When economist talk about the “yield curve” they are really just referring to a plot of yield versus varying bond maturities. An inverted curve is when the difference between the yields of long term bonds (usually 10 year) rates to short (usually 2 year) is negative (short term yields are higher than long). This is a very closely watched benchmark by knowledgeable investors because we know every recession that has occurred in the US over the past 60 years has been preceded by an inverted yield curve, according to research from the San Francisco Fed. Curve inversions have correctly signaled all nine recessions since 1955 and had only one false positive, in the mid-1960s, when an inversion was followed by an economic slowdown but not an official recession, according to the Fed’s data. 

While the US yield curve is still positive (NOT inverted) the global curve just recently inverted for the first time since 2007 where its inversion lasted briefly (less than 6 months).  I have not seen any studies that show if global yield curve inversion has the same strong correlation to economic slowdowns (recessions) as it has in the US, so the implications of the crossover may or may not be of significance.   

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As a minimum though, it raises a warning flag for investors to take the portfolio off autopilot and have a plan. There is no question, a recession, if it were to ensue around the world would likely drag the US along. Economic slowdowns are rarely ever good for stock prices and when combined with us being in the latter stages of the 2009 economic recovery cycle while stock prices are at very extended valuations, next year looks like it could be shaping up to present challenges investors have not had to face in many years.

Dead Money

Those that have followed me for a while know I frequently use the 200-day moving average (DMA) in my analysis to assess the direction of the trend. If the average is rising, we are in an uptrend and want to stay in that investment as it will likely bring higher prices (and further gains). On the contrary, if the average is falling we want to avoid the investment as it will likely lead to continued lower prices and losses (unless you happen to be short the position).

But what about the other option where the average is moving sideways? A good example of this can be seen in the chart of Starbuck’s, SBUX, below.  You can see the (red) 200 DMA flattened out in April of 2016 and has gone nowhere since (a more than 2-year period). The stock is actually down more than 12% since that time, mostly due to last week’s double-digit decline. The US SP500 index, in comparison, is up more than 35% during that same period.

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As investors we are risking capital for one reason only, to make money. A rising or falling 200 DMA identifies environments in which investors can do exactly that. A flat one, on the other hand, is one to avoid as investment capital becomes dead money  

As a side note on SBUX, if price breaks and holds below that very significant green horizontal line of support, a new downtrend will have begun and the first likely target of the decline will be at T1. 

Setting Up

If any of you saw James Cameron’s film, Avatar and were blown away by the graphics and visual effects, then you have seen what Autodesk’s software can do in the hands of experts. Centered smack in the middle of the red hot technology sector, Autodesk’s stock, ADSK, is setting up for a breakout to all-time highs.

As you can see in the chart of ADSK below, price sits well above a rising 200 day moving average and is consolidating just under the $139 resistance zone. Each of the past 3 attempts buyers tried to push through that level it was rejected, indicating an overwhelming supply available for sale.  On the positive side, these past 3 months of sideways chop, a nice-looking cup and handle pattern has developed. A confirmed breakout and hold above the current $139 resistance points to an upside target in the area of $155.

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Cup and handle patterns that have their handle bottoms no greater than 50% of the depth of the cup provide higher probability setups, this one is slightly greater. More importantly shallow handles provide a much higher reward to risk ratio. In the case of this ADSK opportunity, using the handle bottom as the exit point if wrong, the ratio sits at 1.7 (meaning a $1.70 return for every dollar invested). I like the setup but don’t like the ratio as it is less than my preferred target of 3. When it comes to a less than perfect setup, an investor has 3 choices 1) deviate from the investment plan (accept a ratio less than target) 2) move on to the next opportunity or 3) tighten up the exit point.  Hmmm.  Decisions. Decisions.

Forewarned is Forearmed

As you can see in the graphic below, for the most part US equities mirror those of the rest of the world.  Well, at least we can say they tend to both move up and down together. There are times when one of the two considerably outperforms the other. The first instance of this performance divergence occurred beginning in 1986 when global equities turned tail and left US stocks in the dust. It took about a decade before they came back into balance.

For the next 20+ years the two pairs tracked fairly well except just before the 2007-’08 huge market draw-down where foreign stocks, once again, vaulted to the upside. In both cases of foreign stock out-performance, you needn’t look any further than the dollar for an explanation as it fell precipitously, bringing rise to foreign asset values.

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Fast forward to today’s post-apocalyptic 2008 market crash revival, US stocks are massively outperforming. The reasoning may be flipped but the cause is still the same, the dollar. It’s been ripping higher since the 2009 stock market bottom. If you are like me and believe the dollar is on a mission to much, much higher levels, its likely US stocks will continue their tremendous out-performance. Keep this in mind as you rebalance your portfolio. If I am wrong, it will present investors with one the greatest reversion-to-mean trades in recent history. Forewarned is forearmed.