Inflection Point Dead Ahead

In a post at the end of Feb I wrote about the “W” pattern that formed in the SP500. I didn’t mention it at the time but the right leg of the W bottom reflected a sentiment reading of 14, extreme fear. After that sharp 15% decline, as you would expect, no one wanted anything to do with stocks. But we know investor’s sentiment is a contrary indicator and when there is blood in the streets (extremely fearful sentiment), those usually mark the best times to invest. And this time was no different. We have rallied hard to close last week at 2044 just 16 clicks away from my “W” pattern target of 2060.

While we haven’t yet gotten there, the higher we go from here the greater the amount of overhead resistance we will need to chew through which should slow the ascent. As such, I expect sometime this week we start to see a period of consolidation. As with all consolidations it’s where we go after that matters. The market is (soon to be) at an inflection point. Out of consolidation we either punch through overhead resistance and resume the longer term bull market by making new highs or we will be able to look back and see this recent move higher was just a bear market rally and we head lower, a lot lower.  

As with all inflection points, good analysts will be able to make both a bull and bear case.  This time is no different. While I won’t go through the arguments to be made on both sides I do want to leave you with where we closed last week’s reading on the fear/greed index since it is an excellent gauge of market sentiment.

While not at a dangerously high level (85-90) there is no doubt this index is extended and reflecting the wild swing in market emotions. It’s time like these I think back on a very prescient saying from Uncle Warren (Buffet) who said “be greedy when others are fearful and fearful when others are greedy”.

Under the Dome

Polo is an iconic designer name brand led by one of the most recognizable leaders in fashion, Ralph Lauren. The stock, RL, had an incredible run from the 2008-09 financial crisis, rising more than 500% peaking near $180/share. Interestingly, that $180 share price acted as resistance 3x as it failed in May and August of 2013 and once more in December of 2014. Notice how, after that final touch and subsequent decline the (red) 200 day moving average turned down in earnest and continues to point emphatically south. You can also see price has stayed under and respected the blue dome which has acted as resistance on both the way up and now down. In case it isn’t clear, this is a great example of a long term topping pattern and symmetry. A strong rise up, followed by a period of choppy consolidation where price goes nowhere and then finally the decline begins. And the symmetry occurs as prices follows a similar path down (right side of the chart) as it did on the way up (left side of the chart). Burn this into memory as being able to recognize (and act on) these patterns can be very profitable.

Whether you are long (on the way up) or short (on the way down), it’s never easy as there will always be powerful counter trend rallies to challenge your fortitude. In the case of RL, the latest rally off its bottom retraced 20% and the one before that in October of last year rose more than 30%. Those that shorted the stock and hung with it through the many bounces have been handsomely rewarded as it has fallen almost 55% (peak to trough) in slightly over one year (not a bad return, eh?). And from what I see it doesn’t look like it’s done falling. The current price movement has formed a bear flag, retracing to the 50% Fibonacci level an ideal place to begin its next leg lower. If this were to occur, the next logical area for the stock to find support is at the red horizontal line (~$70), another 30% below from where we closed today. There is one black mark on this setup is the positive RSI momentum divergence. This condition is warning short sellers to be cautious and look for a counter trend rally strong enough to unwind the divergence.

As always and as a caveat to readers, all the examples I post on are not recommendations to invest in but rather as illustrations to learn from. With a market environment that I believe is conducive to it, investors should learn how to make money regardless of the market’s direction.

One of the Most Profitable Setups

I’ve written about them in the past and will likely continue to do so in the future because the old adage of “from false breaks comes big moves” is one of the most profitable investment patterns. An excellent example was detailed in my Feb 15th post where GDX, the mining stock ETF, exhibited a failed breakdown. From that point It has since risen more than 60% in just over a month’s time. Another example of a failure (except this one to the upside) is in the chart of LGI Homes, LGIH, below. You can see price broke out to all-time highs on huge volume on December 1st. While you didn’t know it at the time, the huge volume on that day was a sign of exhaustion selling and helped confirm the reversal. Within two days of that breakout high, sellers stepped in and flooded the market dumping their shares. An investor who recognized the pattern and shorted the shares on the breakdown made a cool 40%+ in just a couple of months. Notice how, at the low last month, price formed positive divergence which warned of an impending reversal and gave those short prescient notification it was time to lock in profits.

While the failed breakout selloff is likely done, the LGIH story may not yet be over. The positive divergent formed with February’s low combined with one higher high and one higher low has formed a bullish inverse head and shoulders pattern. This patterns target, if confirmed is $29.9 a bit more than 20%+ to the upside.The Dec-Mar sideways action has formed a nice base from which the stock can make its next move. With price just below a rising 200 day moving average and RSI momentum is in the bullish zone and rising, it looks like that move could be higher. For me to be a believer though, I need to see price break above the red horizontal resistance level on high volume and stay above for 3 days. With the markets overextended to the upside in the short-intermediate time frame, buying any stock here, even one as well setup as LGIH, is additional risk investors need to consider.

Bonds ... Where to From Here? Rev 2.0

Back in January I wrote about the US long bond forming a symmetrical triangle pattern. Because of their fickleness I was not confident on the direction it would take (I leaned to the upside) but the pattern suggested a 10% move, whichever way it broke. I took a lot of flak on my contrarian lean to the upside direction as everyone was confident future FEDs action would push rates higher (and bond prices lower)

Bringing this chart up to date you can see price did break to the upside and the move (from breakout to peak) hit its 10% target in just 5 short weeks. As Hannibal Smith from the A-Team used to say “I love it when a plan comes together”.

Because the fundamental backdrop has not changed and this move was “contrarian” it is important, once a move has completed its projected move, to take some (if not all) chips off the table and review the charts for clues about what may lay ahead.  To do this, I find it best to shorten your perspective and look at a daily chart.

No matter the chart I see patterns and this is no different. The current setup has the appearance of a bull flag. It became overbought (RSI momentum in upper pane) and needed to unwind that condition which it has and still remains in the bullish zone. The red 200 day moving average has begun to slope upwards. As such, I would be interested in this security if price breaks above the upper blue boundary of the flag as the upside pattern target is another 8-10% higher. To confirm a break, I would like to see it occur on higher volume.

If, on the other hand, prices breaks down below the lower blue flag boundary or if it doesn’t break higher within the next 5-10 trading days, all bets are off.

February’s Charts on the Move

The oversold, divergent rally began as expected and is still in full force as we close out the month of February.  The charts are pretty clear on the message they are sending. If you aren't, take a listen to my latest video at the link below and get my take on where i think we go from here.

https://youtu.be/KL4TEO8nwg0

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