A Couple of (conflicting) Sentiment Data Points

As you can see, US corporate CEO’s have historically been very accurate in being pessimistic (predicting a recession) at just the right time in the past. While not quite below the line, it looks like we are just a whisker away based upon the most recent data.

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Optimism among individual investors about the short-term direction of the stock market fell to its lowest level in three and a half years. The latest AAII Sentiment Survey also shows a jump in pessimism and lower neutral sentiment.

Bullish sentiment, expectations that stock prices will rise over the next six months, declined by 1.1 percentage points to 20.3%. Optimism was last lower on May 25, 2016 (17.8%). Bullish sentiment is below its historical average of 38.0% for the 33rd time this year and the 21st time in 22 weeks.

Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, pulled back by 3.5 percentage points to 35.7%. Even with the decrease, neutral sentiment is above its historical average of 31.5% for the 20th time in 21 weeks.

Bearish sentiment, expectations that stock prices will fall over the next six months, rose 4.5 percentage points to 44.0%. Pessimism was last higher on August 14, 2019 (44.8%). Bearish sentiment is above its historical average of 30.5% for the 10th time in 12 weeks.

Bullish sentiment is at an unusually low level for a second consecutive week. Pessimism is at an unusually high level for the first time in six weeks. Historically, such readings have been followed by higher-than-median six- and 12-month S&P 500 index returns. The link is stronger with unusually low optimism than it is with unusually high pessimism.

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 For bulls this is great news as we know individual investors are usually wrong, so sentiment readings at the lowest levels since 2016 is very bullish. Historically, such readings have been followed by higher-than-median six- and 12-month S&P 500 index returns. The link is stronger with unusually low optimism than it is with unusually high pessimism.

Elevator Down?

Having been schooled by one of the greatest chart pattern traders ever (Peter Brandt), has given me a love and appreciation of the art. For those who don’t know, little of mastering and succeeding at the skill is about pattern recognition but instead, risk management. As it turns out, that is no different than anything when it comes to the investment world.  

As you can see in the PAGS chart below, a textbook head and shoulders pattern with negative RSI momentum divergence is screaming out “SHORT ME”. Well, not immediately because every pattern needs a confirmation before entry, this one being when price falls and stays below the green horizontal support line. If that were to occur, the pattern’s target is down at T1, a nice 30+% decline. As ideal as this setup is, the probabilities of failure are good because the overall trend of the stock market over time is up and any short would be taking a position against the longer-term trend. So, a decision has to be made either and then decide whether to avoid the lower probability setup (even as good as the setup looks) or take it and keep a shorter leash (minimizing losses) in case you are wrong.

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The fun thing about shorting is that when they work, they typically work much faster than from the long side. As they say, stairs up, elevator down.

Avoidance

The last few months has been frustrating bulls and bears alike. Most breakouts have failed, if not immediately soon thereafter. Breakdowns for the bears have been equally as exasperating. While there has been a bit more success being on the short side, for the most part with a few exceptions (software stocks) confirmed breakdowns have shown little follow through.

Biotech has been weak for a year now and shows no signs of changing character. Looking at the chart of IBB, the (larger cap) biotech index, you can see it continues to stay below its downtrend resistance and currently sits precariously on an important level of support. The path of the last 6 months of its price movement has formed a bearish descending triangle and its breakdown seems eminent. Further weakness in the coming weeks opens the door for the possibility of a much bigger decline, a likely target is at down near last December’s lows.

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Its rarely talked about but outperforming is as much about avoiding big losses as it is about picking and staying invested in the winners. With that in mind and at least for now, biotech is a place most investors should be avoiding.

A New Beginning?

I posted a few months ago about the breakout in gold. It was so obvious it made me wonder whether it was going to turn out to be a fake out. I had my doubts. At the time, it was a textbook technical setup for a trade not a long-term buy and hold position. Since then, from a purely price perspective, it has done everything an investor could hope (up ~10% in less than 3 months), pausing where it should have and looks like it is ready to complete the initial breakout pattern as it is making a push to its upside target. In spite of all these positives and because we want to only be over-weighted investments that are outperforming the benchmark, there was no reason to be over allocated because it has been under-performing the US stock market (SP500 index) … that is until just recently.

Ya gotta love ratio charts as they easily let you compare investment performance and thereby providing a path to improve performance. Remember, when looking at a ratio of gold to the SP500, if the ratio is falling, gold is under-performing and when the ratio is rising, gold is outperforming. Taking a look at the ratio of gold to SP500 chart below, you can see gold has been severely under-performing US stocks for 7 years. In fact, the SP500 has outperformed gold by more than 70% over that time period. For gold investors, those were 7 lost years. What is very interesting is the chart is now telling us that probability of future under-performance from holding gold may have ended. Notice how the ratio has broken the long-term (red) downtrend line? Just breaking the trend line is only a start. To confirm, after the break you want to see a new uptrend beginning as defined by higher highs and higher lows.  I have illustrated the chart to make its recent confirmation clearer … #1 marks the first higher high, #2 the first higher low and #3 the second higher high. If, (this is a big if) the ratio goes on to make another higher low, we can say with high confidence that the secular under-performance of gold in relation to US stocks has ended.

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Why this is such a big deal is because gold has historically been an investment that trends and trends for long periods of time (years). If this is in fact the start of a new secular trend, it’s an ideal time for investors to begin rotating money out of US equities and into the precious metals complex.