November Review and December Forecast

Over the last 2 weeks we have discussed Gold market and the Bond market, in terms of their structure and sentiment, to understand the next rally phase. Detailed analysis can be reviewed here:

• Bond Market Analysis
• Gold Analysis (Part 1 - Structure, Part 2 - Sentiment)

As we enter a new month, its critical to quickly review last month and then try to understand where things could go in the last month of 2016.

November 2016

Elections 

At the beginning of November, market experienced a sustained consecutive negative days. This negative behavior, not only tilted the sentiment to bearish and technical indicators to oversold, it also completed the correction pattern. This completion gave way to an amazing rally. We discussed the upcoming rally several times in following posts:

• Reasons to be Bullish - From Twitter

• Elections and the Stock Market

even though few people will remember this fact but the market started rallying even before the election on the news that FBI had dropped the investigation involving Hillary Clinton's e-mail. At that point, people attributed the rally to Mrs. Clinton's impending victory. However, as Mr. Trump won and the market continued its rally, it took many by surprise. 

This tells us that news/economic/political events don't matter. It's the reaction to these events that matter. And one of the best ways to gauge the reaction objectively is by looking at the price structure and sentiment indicators, along with forecasting strategies. 

Correlation with the US Dollar

Even more interesting is the fact that this rally has come in sync with rallying US Dollar. Typically, when US Dollar rallies, all asset classes are impacted. And if not directly impacted, they find it difficult to rally. But following chart shows the amazing correlation between US Dollar and the stock market:

Divergence with Advance Decline line

While this rally has made a lot of market commentators excited about the prospects of a major rally and 2017 with prospects of a major stimulus, this rally wasn't substantial enough to eliminate NYAD divergence.

Divergence in Advance Decline issues is critical for a sustained rally. This doesn't mean that this current rally cannot move much higher, it just means that the near-term rally could face challenges to continue in face of this divergence.

What's Next in December?

In summary, we have credible reasons to believe that the recent stock market rally is extended and we could see a market correction over the next 1-2 weeks (probably till next IPM turn window). While Stocks market corrects, asset reallocation can take place with money flowing into oversold sectors like Gold and Bonds.

Since US Dollar is also extended, a correction in the Dollar index will also support Gold rally. On the other hand, Fed FOMC meeting and an announcement to increase the short-term rates can also reduce some of the uncertainty from the Bond market, which could result in reprieve rally for Bonds.

Market might resume its uptrend in the 2nd half of December. However, the velocity of the ascent might not be as significant, as it has been in November.

Lastly, for Gold it is a do-or-die point. It needs to rally above 1205 in the next few weeks or it will likely enter another bear market.

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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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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.

 

Implications of the Presidential Elections

As mentioned in the last post, last 3.5 years saw doubling of the stock market prices i.e. from 6500 to 13000 (DJIA). Under such circumstances and keeping in mind that humans have a short memory span, it was very difficult to beat the incumbent President in the Presidential Elections. We can also say that Mitt Romney chose the wrong time to participate in the elections. 

Yesterday’s elections were a clear representation of the optimistic social mood. Everyone knows that the last 2 years have not resulted in any productive legislation, but even with such a bad record voters voted to keep the status quo. This voting behavior highlights how people think and how they perceive the stock market as the barometer of the health of the economy. In any case, yesterday's results will have far reaching implications for the entire country.

FUNDAMENTAL/POLITICAL ANALYSIS

We all know that during the last 2 years, when House was occupied by the Republicans and Senate was led by the Democrats, we did not see anything constructive in Washington. We only saw political point-scoring and bickering over critical issues like budget. This situation is going to continue over the near future, which means that nothing significant will be done for the economy. Thus, we might soon experience the fiscal cliff, sequestration and/or budget cuts. All of these actions will be detrimental for the economic growth. At the same time, Democrats will push their agenda for the tax hike which has been a contentious subject for Wall Street. In short, status quo is a bad omen for the American economic outlook.

SOCIO-ECONOMIC PERSPECTIVE

As far as the stock market is concerned, the optimistic social mood was the key driver behind President Obama’s success. However, as we all know that after a sharp decline, markets typically retrace a big chunk of the initial decline. A similar situation happened in the U.S. markets i.e. after the great crash of 2007-2009 market retraced almost 90% of the decline. The only problem is that this rise was subconsciously attributed to the sitting government, whereas in reality the market rally was not a function of actions performed by the President but was a function of time i.e. it was supposed to happen. In any case, people started feeling optimistic about the market and hence voted for the person, under whose tenure the market bounced back.

As mentioned previously, Voting/War is the final manifestation of the social mood (happen towards the end e.g. wars typically happen near the end of the bear market). It will be appropriate in Elliott Wave terms to find out after 2 years that the stock market topped in October 2012 (right before the 2012 Presidential Elections, which were won by the incumbent President and soon after the QE Infinity announcement by the Federal Reserves).

TECHNICAL ANALYSIS

• Since Elliott Wave analysis measures social mood in terms of the stock market, it is currently suggesting that we are starting a protracted decline phase, given that we do not break above October 5 highs. Detailed Elliott Wave analysis will be presented later. 
• Please also note that the Global Dow, unlike DJIA, is well below its April 2011 and March 2012 highs. This divergences between US and global markets, is another very dangerous sign for the market in the near future. 
• Finally, completion of the 8/4 test means that we are about to embark on a prolonged downtrend. 
• IPM model will help keep you informed of upcoming turn dates, so that one can take advantage of trading opportunities. IPM Model predicted the October top in September and has had an accuracy rate of ~92% over the past 3 years. IPM Model updates are available at subscription. 

CONCLUSION

After exhaustive analysis of social mood extremes, future decline potential and market trajectory reasoning, a very interesting conclusion is reached. Details will be provided in the next post. But in short, humans are supernaturally forced to make detrimental decisions, at the most critical junctures of time. And I think we just made one such bad decision (I hope that I am wrong !!) 

Stock Market & Presidential Elections 2012

Our lives and our decisions are governed by our moods. We live as per our mood (socialize if we are happy, stay introvert when depressed), we eat according to our mood (spend when we think we have money and are happy, or sleep with a just Ramen noodles when we are tired or are not affluent), and spend what we feel like. In short, our actions are governed by our mood swings. In the same respect, we vote as per our mood i.e. if we feel good, we vote for the incumbent. On the other hand, if we feel bad, we register revolt through our vote. In other words, voting is the best representation of the collective social mood of a society.

Another way to analyze the social mood is through the stock market, because Stock Market is the barometer of the broader social mood. When market rises, optimism increases and when it declines, pessimism saturates. This cyclic behavior is so common that it gave way to the contrarian trading strategies. This is because society’s collective optimism peaks near the top, while collective fear peaks at the bottom. Although there are many ways of measuring the sentiment, this article will address the relationship of people’s vote and the broader social mood.

At this point it is clear that both Stock Market and Voting exhibit social mood. The only caveat is the delay between the social mood exhibitions through the Stock Market VS Voting. If one wanted to assign a timeline to social mood exhibition, Stock Market would be the first responder, while geo-political events will be the last responder. This is because the social mood pushes the society to take actions in accordance with the broader social mood. These actions range from Voting out the incumbent leader to starting a War with another country. The interesting to keep note of is the fact that this social mood change is typically displayed through the stock market price pattern.

Now, if we look at the current situation from the stock market perspective (shown below), it is very clear that the market has been rising under President Obama’s administration. In fact the market has more than doubled under Obama since March 2009.

DJIA: 6500 ==> 13500

Gold: 900 ==> 1800

Oil: 35 ==> 90

This stellar stock market and commodities market performance along with the latest consumer confidence reading (consumer confidence is touching 4-year highs) and the low VIX numbers, clearly suggest that the social mood is very optimistic. Although we know that these 100% gains are a factor of prior market collapse, the short-term memory of the populous will allow these gains to work in the favor of the president. 

In past, when mood has been this optimistic, we have rarely seen an incumbent losing the elections. In other words, no matter how bad President did during his tenure, he has done enough good to keep the asset prices afloat, avoid a second recession and bring back optimism among the masses about the future of the country. Therefore, from a stock market and social mood perspective, President Obama is the favorite to win today’s presidential elections.

However, if the President loses today, it would mean that elevated stock market prices are not the sole representation of the Social Mood. And that people do take into account their personal situations when dealing with things like elections.

Next Post: Implication of Election results on the Stock Market (An Elliott Wave perspective)

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