Stocks Approaching Dangerous Levels

Yesterday's rally in all of the major indices $DJIA, $SPX, $EEM, was very well received and triggered many tweets regarding Dow being at all time highs. Even President tweeted that stock markets are doing Great! I would recommend against such tweets because:

1. What happens when the market goes down? If one owns a rising market, they would have to own the declining market as well, which could be much more negative.
2. Market risks are increasing and we are close to a turn in the markets, which will correct post-election rally. Hence, a deeper correction can be expected. 

Following analysis supports the correction hypothesis (not a Bear market for now). Please note that below analysis is predictive and unlike mainstream finance, which is reactive, this analysis helps in understanding potential market move before time. This analysis also plays a pivotal role in our client portfolios (H1 2017 Performance has been shared). There are four key components:

1. Structure
2. Technical/Divergence
3. Market Timing
4. Sentiment

This correction could last for few weeks/months before resumption of the trend because we don't see a Bear market right away. But do you want to be part of a market when its going down and the headlines are negative? Some investment suggestions are included at the end.

Structure
Firstly, the Elliott Wave structure is nearing completion. Once this 5-wave rally completes, we will see a decline. Next decline could bring DJIA back to ~20,500. As for the upside, if current structure (As shown below) holds, Dow Jones Industrial Average cannot exceed 22,000, which is less than 500 points from yesterday's close.

One of the lesson that we have learned over past several years of market analysis is that one cannot and should not blindly believe on Elliott Wave structure without considering the market backdrop.

Divergences
Inter-market divergences highlight discrepancies between markets. These discrepancies typically take place in 5th wave where markets start diverging. We can currently seeing a divergence between SP500, DJIA and Nasdaq (shown below).

  

Please note that these divergences don't mean that long-term trend has reversed. On the contrary, there are no signals (structural or momentum) that this decline could lead to a new bear market.

Timing
Our proprietary market timing model has a key market turn date scheduled for July 14 (+/- 4 business days). Therefore, we can expect a top by next week.

This model has worked very well in the past and also serves as a key component of our proprietary strategies. We are working on developing a unique trading system around IPM, with potential go-live in 2018.

Sentiment

Following charts show that sentiment is very elevated. 

Long positions in DJIA are at all time highs, which does not bode well for a sustained rally.

Investor Intelligence survey respondents are mired in the bullish region for quite some time, and same is the case with Naaim survey results (charts courtesy of Babak).

 

Lastly, these two are very interesting.

TD Ameritrade users are very Bullish and are showing it with their trades. Since these are real retail investors, them being so bullish doesn't bode well for the markets.

More than half of E-trade users are also optimistic regarding the prospects of the market, which is another warning signal (Courtesy Noon Six Cap)

Positioning

Markets are at a critical juncture. Preparing for such a decline will depend on personal risk tolerance and tax considerations. Everyone should evaluate their investments through following key investing questions:

1. Am I ready for a stock market trend change?  
2. Will I have the mental strength to go against the herd?  
3. Can I take advantage of new opportunities?

If you think you have too much exposure to stocks, you can reduce some exposure to be able to buy again. If your comfortable taking a hit to the portfolio knowing that you might not be able to enter back in time, it's better to ignore the news and remain invested. Worst thing a person can do is not reduce exposure at top and then get stressed with market/news, ad get out at the bottom, only to see a resumption of the rally.

Alternative Solution: We are helping clients answer above questions every day. And have developed our proprietary strategies to generate consistent returns, while taking advantage of new market opportunities and minimizing existing risk. We aim to provide Absolute Return Hedge Fund like strategies for individual investors through Managed Account model.

Feel free to contact us with any investment questions or if you would like to invest with us (Performance - H1 2017):

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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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