Royal Dutch Shell

I had an annual review meeting with a client a few weeks back and as we were wrapping it up he asked me what I thought of Royal Dutch Shell as an investment.  I commented I didn’t have an opinion but would provide one once I looked at the chart. He went on to say he was watching CNBC and (Jim) Cramer was promoting the stock.  I went on to tell him that the evidence supports that you would have had a better chance of making money by flipping a coin than following in his calls. In fact, you would have made more money if you had done just the opposite of what he said. Without skipping a beat my client said “he can’t be wrong all the time can he?” 

There have been many studies done that show that “experts” (I prefer not to get into a debate on whether Mr. Cramer is an “expert”) as a whole don’t provide better recommendations than flipping a coin.  An example of such a study is where they initially asked 3 groups to predict the future price of a security initially given 6 pieces of relevant information.  What they found was all three groups (experts, a computer and those deemed “financially unsavvy”) all performed equally, none better than a coin flip. The second part of the study continued to progressively deliver more and more relevant information about the security until they were given 20 pieces in total. What they found was quite interesting. The computer improved its ability to forecast (increased to more than 60%), the financially unsavvy had no change (stayed at 50-50) but the “experts” ability fell from 50% to near 20%. There are reasons why this happen and for the sake of brevity it’s not relevant to this post.  What is relevant is anyone listening and then acting on forecasts or predictions of the financial future will likely be disappointed.

The CXO Advisory Group (you can find more information here) provides a great service (some free some is subscription) where they deliver objective research and reviews to aid investing decisions. The thing I found most interesting is their “guru grades” (this section is free) where they assess the forecasting acumen of stock market “gurus” as a group and rank them as individuals according to their accuracy. In the paragraphs following this one, I have cut and pasted the results from their webpage. I am sure you have heard of some of the names covered but most will likely be recognizable only to industry insiders. Please keep in mind, there are always risks in drawing conclusions about individual results, especially those with small sample sizes.  What their results do illustrate (and reinforce from numerous studies) is there are a few that get it right more often than not but on the whole, you would be no better off than if you flipped a coin.  Forewarned is forearmed when it comes to listening to the noise on the financial networks and those who consistently attempt to forecast the future.

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Individual Grading Results

The following table lists the gurus graded, along with associated number of forecasts graded and accuracy. Names link to individual guru descriptions and forecast records. Further links to the source forecast archives embedded in these records are in some cases defunct. It appears that a forecasting accuracy as high as 70% is quite rare.

Cautions regarding interpretation of accuracies include:

Forecast samples for some gurus are small (especially in terms of forecasts formed on completely new information), limiting confidence in their estimated accuracies.Differences in forecast horizon may affect grades, with a long-range forecaster naturally tending to beat a short-range forecaster (see “Notes on Variability of Stock Market Returns”).Accuracies of different experts often cover different time frames according to the data available. An expert who is stuck on bullish (bearish) would tend to outperform in a rising (declining) stock market. This effect tends to cancel in aggregate.The private (for example, paid subscription) forecasts of gurus may be timelier and more accurate than the forecasts they are willing to offer publicly.

And in case you are interested … Royal Dutch Shell is down more than 10% from the day I had my client meeting.

The Trouble with Triangles

I know I lured in some unsuspecting geometry haters but this week’s blog post has to do with the chart pattern rather than the geometric shape.

The chart below is a 5 year weekly look at the Chinese Stock market ETF, FXI.  You can see while price has swung up and down as much as 30% from its mean, it really has gone nowhere over the entire 5 year period. Also, you can see since the 2010 high, price has traded within a triangle bounded by the blue trend lines. Triangles are consolidation patterns and while we try and avoid consolidation zones they should not be ignored because eventually they lead to a breakout.

Breakouts are what every investor dreams to find because they can be the start of a new trend. And trends are where investors make money, not areas of consolidation.  All patterns in technical analysis have probabilities associated with their outcome. Technicians look for the patterns with the highest probability as that logically improves investing success. The higher the probability the higher the success. Now, here is the trouble with triangles they have no edge.  They provide no statistical probability greater than flipping a coin. Because of their 50% probability of breaking either up or down, you should wait for the breakout before entering a position.  To make things even worse, if you buy the breakout, there is an equal  probability it will reverse back in the other direction.

My chart of FXI is a perfect example of what I tried to explain above and why I hate triangles.  Price broke out to the upside (bullish breakout) which pulled in new investors thinking this was the start of a new bullish trend. After a 10% rise, almost up to the prior late 2010 high, price immediately reversed and fell right back into the triangle where it sits today. Those who bought the breakout and were not prepared with an exit strategy are likely now sitting with a loss. Those who were familiar with triangles could have entered with a tight leash and may have been skillful enough to have eeked out a small gain or better yet, have avoided this investment altogether.

Now you know the troubles with triangles

Crossroad

When the stock market moves (up or down), the strength of that move is dependent upon how many stocks are participating in the direction of the move. For example, the more stocks that are going higher, the not only the higher the market goes but also the longer that move can last.  Logically, the inverse is true too.

There are many ways to slice up the US stock market but one of the simplest ways is to look at it by company market capitalization. Since the start of the year we can see in the chart below that performance has been directly proportional to market size. The largest companies (in red) have outperformed the mid-sized companies (in blue) which have, in turn, outperformed the smallest companies (in green).   As you can see, the smallest are actually negative for the year.  In a bullish environment we would expect to see all 3 segments moving up strongly together.

Looking at this same information for the current quarter shows not only the continuing performance to size relationship but a something a little disturbing.  Not only are the small caps (600 stocks) negative but the mid-caps (400 stocks) have turned down too.  This shows a deterioration in the underlying market structure.  Right now, the only thing holding the market up are the generals (the largest stocks).

The market is at a crossroad right here, right now and until it can get broader participation from the “soldiers” (small and mid-sized companies), further gains will be limited and an increasing chance that long overdue correction is at our doorstep.  

Panera Bread - PNRA

Panera Bread - PNRA

In 1987 the St. Louis Bread Company opened its first location in Kirkwood, Missouri. Panera bread is the newer name for St. Louis Bread Company outside of the St. Louis area. In 1993, Au Bon Pain Co. purchased the St. Louis Bread Company and operates more than 2000 locations.

Since May of last year when the price of PNRA peaked at just under $195, share prices have been in a downtrend printing lower highs and lower lows. In August after a 25% decline from its high, a tradable bottom was formed and (at least for the time being) prices have reversed course and have established a new uptrend, now closing with higher highs and higher lows. Earlier this week strong momentum pushed the price above an important line of resistance (red horizontal line).  With that important line breached and armed with the confidence of an interim bottom in place and a new (for the time being) uptrend established, investors should be pondering if this is a good time to hop on board.

From my perspective, other than the overbought condition (see upper RSI pane), the chart pattern looks fairly attractive. Remember, overbought conditions should just raise a flag because ultimately being overbought is a sign of strength and is very desirable if you own a stock.  Who wants to buy stocks when their prices are stalling?

If I were investing in PNRA (and I am not at this time nor am I recommending you do) I would wait for a pullback in price which would have the effect of unwinding the overbought conditions. If price falls back to the red line of support (what was resistance becomes support) or above and holds above it I would consider taking a position. If price falls back below the line and stays, this would signal the sellers are wrestling control away from the buyers which would be enough to have me turn my attention to better opportunities.

Brazil – Terra da Santa Cruz

The long term investment prospects for Brazil are exciting and are nicely detailed here.  What should pique investors interest is the potential for outsized profits as experienced in in the early-mid 2000’s where the price of the Brazilian market was up more than 1000%. As with all investments, being patient and finding attractive entry points can help maximize any opportunity.  Below is a weekly chart of Brazil showing price action since the bottom in 2009 until May of this year.   Hopefully it’s obvious the Brazilian market has been in a poor investment since 2011 as it has printed lower highs and lower lows. Being invested during this time has been a painful, losing proposition, as the Brazilian index has fallen more than 40%. As an investor, the further something falls the more I become interested because the greater the fall the greater the chance for a big snap back rally.  As always with investments who's price is falling, the question is always when does it become worthy of your investment dollar as we all would prefer not to be catching the proverbial knife.

As I have mentioned many times throughout the years, I find that weekly, oversold conditions with divergence creates the high probability for an attractive entry point. The Brazil ETF, EWZ, created that exact setup early this year. As you can see below highlighted with the red circles, price fell while momentum (upper RSI pane) increased.  That divergence was the first flag to get ready for a possible entry.  From the lower price low in February priced moved higher, eventually breaking above the blue down trending channel.   The final buy confirmation an investor would like to see came when volume (lowest pane) increased leading up the breakout. 

Switching to a daily chart and looking at price since the low created in February shows a great example of an uptrend, higher highs and higher lows. In addition since April, price has been nicely contained within the blue ascending channel. That is until the start of September where it broke out to the upside and then again last Friday where it broke down. The 10% decline over the last week and a half are tough for investors to stomach as you have seen profits quickly disappear. Other than to have a direct vision into the future it would have been nice to be warned ahead of time the chance for a breakdown was in the works in order to lock in profits.

The fact is there was ample warning you just needed to know where to look. The market provided 3 signals all which happened around the same time and provided an early opportunity to take evasive action.

1.       Price closed outside the Keltner channel (green band) for 3 consecutive days. This is a signal price has moved too far too fast and warns of a potential reversal ahead. What it doesn’t do is indicate how big that reversal will be.

2.       The highest candlestick on the breakout (highlighted within the red circle) and the ones just before and after formed a rare evening star (bearish) reversal pattern which was provided the 2nd confirmation of trouble ahead.

3.       Trendlines are important and as you can see price closed above the upper blue support/resistance trendline. A breakout can be either bullish or bearish you need further confirmation before acting on any break. And we got the confirmation we needed within the next 3 trading days. There is a very important maxim that states “from false breaks comes big moves” (in the opposite direction). This is a great example of that maxim as it played out exactly. Price broke out to the upside and then quickly reversed (false break) and fell hard.

4.       While not a warning sign, the big volume spike that occurred (reflected in the lower pane) is the greatest I could find over the last 5 years.

While I am always on the lookout for good investments that  have been oversold, there is nothing in the charts that says the "bottomz in" for this current decline. The markets could quickly change all that next week but for now I will personally be avoiding Land of the Holy Cross until further notice.