The Deflationary Boogeyman

Commodities have been a horrendous investment since they peaked in 2008. Since that time, using the $CRB commodity index as a proxy the index, has lost almost 60% of its value and those investors who have bought and held have been crushed. This is reflective of the ongoing deflationary cycle that started in 2008 and what central banks around the world are trying to fight, many using untested and potentially dangerous means. I have learned it is best to avoid political or third rail sensitive topics and keep my posts solely about investing, the fact is I have major doubts this misallocation of capital and demand pull they are causing will end positively. They are using everything they have in their arsenal and are running out of options fighting the deflationary boogeyman trying to create inflation.

For those who listened to last month’s market recap, I mentioned the elephant in the room was the dollar as it appeared to be breaking out of a consolidation pattern to the upside and the potential impact on investments. In today’s post I wanted to show how I came to that conclusion. The chart below shows RSI momentum in the upper, the dollar in the middle and the $CRB index in the lower pane. What should jump out at you besides last week's breakout of the triangle, is the strong inverse relationship that exists between the dollar and the commodity index. When the dollar rises, commodity prices fall and vice versa.  For the sake of this discussion, if you assume my analysis about a rising dollar correct, you can see how a breakout higher could have very serious consequences on commodity prices.

Triangle patterns by themselves are some of the most notorious patterns for false breakouts so I am cautious in my breakout call and continue to wait for further confirmation. On the flip side, bull pennants which are a long pole attached to a triangle, are much more reliable and typically mark the halfway point of an entire move. Using that info to project forward, another move higher by the dollar equal to the most recent move could poleaxe commodities another 40% or more. Clearly the market could do anything and my hypothesis is but one possible outcome, but if this were to occur, savvy investors should look to find ways to capitalize on this move as the potential is captivating.

Dead Cat Bounce?

The energy sector has been the whipping boy of the US market for the past 18 months or so. XLE, one of the big “2” energy sector ETFs, has lost more than 40%, high to low, during this time. In the weekly chart below you can see in August price bounced off prior support in the $57.5 area as it did in mid-2012. It should be easy to recognize we are in a downtrend as price continues to make lower highs and lower lows and has stayed below the downward pointing 40wk moving average which has acted as resistance the entire move. Additionally, RSI momentum in the upper pane has confirmed the bearish trend change as it has transitioned from the bullish range (40-80) to the bearish zone (20-65). When all of these align up together as they have, it is an indication of a strong downtrend.

All trends eventually end and at some point energy investments will turn out to be a compelling long term buy but until the following occurs I view the current bounce off support as a short term trade only.

1)      Price makes one two higher highs and one higher low

2)      Price moves above the 40wk moving average

3)      The 40wk moving average has a positive slope

4)      Volume needs to confirm the upward price movement by rising as prices rises and decline as price consolidates.

While it is not ideal, the current movement looks eerily similar to the prior other 2 bear flags that formed since price peaked last year. I hope my analysis is wrong but when looking at the weight of the analysis, I expect we get another leg down, likely occurring after finding resistance at the upcoming 40wk moving average. Traders will see that as an ideal time to short and capitalize on the ongoing energy weakness entering on a dead cat bounce.  For longer term (long only) investors, look for the next leg down (the $40 level looks like a logical target) to create an oversold divergent low which, if it occurs and is confirmed by the 4 requirements above, will present an excellent long term entry signal.

October Market Recap Video

It turns out September was the low of the correction as October turned out to be one of the strongest monthly rallies in recent years. While I expect we will be in for some choppy action into the New Year, I do think the bias is to the upside.

Below is a link to my October 2015 Market Recap.

https://youtu.be/NvVmiZV2caM

Time to Rally? Look no Further than Seasonality Patterns for Clues

In many recent communications I have been mentioning my expectation of a coming seasonality market rally. The reasoning is there are a couple of positive seasonality patterns that occur that are now coming into play. One of these patterns is due to our recent back-to-back losing months for the market in August and September.  This is the first time since 2011 this has occurred and historical performance suggest an expectation of a robust balance of Q4 performance. Looking at the Stock Trader’s Almanac we find going back to 1930 (85 years, excluding 2015), the combination of a down August and a down September has occurred 18 times (21.2% of all years). Of those 18 past years, the following October was up 11 times and down 7 with an average gain of 1.82%. Fourth quarters in those same years have an even better record, up 14 and down 4. The last losing Q4 was in 1977. Recently, the last three down August/down Septembers in 1999, 2001 and 2011 were followed by double-digit gains in the fourth quarter. 1999 and 2011 were presidential pre-election years, just like this year.

There are, of course, no guarantees but the probabilities of this seasonality pattern combined with that of the expected annual Santa Claus rally are compelling arguments to insure your accounts are adequately exposed to risk assets through the balance of the year.  As always, it is critical to have an exit strategy mapped out beforehand incase the market wants to prove the seasonality thesis wrong.

Name Your Own Price

It’s hard to believe in the early 2000’s Priceline stock (PCLN) fell more than 99%, bottoming 2x in 2001 and again 2003 at a weekly close under $8/share. A little luck (the internet boom) and a major business model overhaul has pushed the stock on a relentless path higher, currently testing all-time highs above $1350/share  

In the weekly chart below, it’s clear to see why this stock has been a long-time dream for trend followers as it has stayed above its rising trend line for years. Like all investments it goes through consolidation periods, the first one on this chart was a sideways channel that lasted 11 months from April 2011 through Feb 2012. Once it broke out from the channel it rose ~40% in less than 3 months and started its next consolidation. The second consolidation formed a saucer (or cup and handle) pattern and lasted about 13 months finally breaking out in May of 2013. From that point price rose ~80% in 10 months, peaking in March of last year. Since then, price has again been consolidating and once again formed another saucer pattern. Notice how each of the moves out of consolidation higher create an overbought RSI momentum condition (in the upper pane). While overbought conditions are good as they are the hallmark of strong trends, they also have a limited life and eventually need to be unwound. The unwinding process allows the bulls to go reload. During that reloading process bulls want to see the RSI reading stay above 40, otherwise it is at risk for a direction change.

As a trend follower, strongly upward trending stocks that are consolidating and have not yet broken out are the frosting on our cake.  A break above the current upper horizontal resistance line supported with increasing volume would trigger a model buy signal. Of course, price could just as easily reverse course and begin a new bear market.  There just are no guarantees. Most likely we will find out our answer to this question very soon as they are set to release their latest earnings announcement on Nov. 9th. Based upon the chart patterns and the market’s reactions to past earnings I am leaning heavily toward this consolidation being the pause before its next leg higher.