Politics and the Economy

While the markets take a breather and consolidate I thought it be fun (or not) to step away for a quick look at politics (a subject I try to avoid). The WSJ asked economist’s their view on the potential impact the individual presidential candidates would likely have on the economy.  Like all predictions, I put zero faith in the results but find the discussion interesting and fodder for some fun. 

Q: Why did God create economists?      A: In order to make weather forecasters look good.

Three econometricians went out hunting, and came across a large deer. The first econometrician fired, but missed, by a meter to the left. The second econometrician fired, but also missed, by a meter to the right. The third econometrician didn't fire, but shouted in triumph, "We got it! We got it!"

A physicist, a chemist and an economist are stranded on an island, with nothing to eat. A can of soup washes ashore. The physicist says, "Lets smash the can open with a rock." The chemist says, "Let’s build a fire and heat the can first." The economist says, "Let’s assume that we have a can-opener.”

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More than three-fourths of forecasters in a new Wall Street Journal survey say the presidential election has introduced more uncertainty than is typical from a change at the White House.

Their current economic forecasts aren't all rosy: On average they see about a 20% risk of recession in the next year, down slightly from 21% in the previous survey. They forecast the economy will be too fragile for the Federal Reserve to raise rates before June. They predict the economy will add fewer jobs this year than in 2014 and 2015.

More than four-fifths of economists rate the possible election of either Mr. Sanders or Mr. Trump as an outcome that may force them to lower their economic forecasts. About half the survey’s respondents rate them as “significant” risks. Regardless of who wins, it is unlikely the new president would be able to change policy quickly enough to affect 2017.

As with most things, the economists polled could not reach consensus, unlike their past recession predictions where they accurately forecasted 29 of the last 3.

Bad News: People Are Saving More

With the market at what I consider to be a crossroads, I have dozens of setups I could show that are both bullish and bearish opportunities. But they can’t both be right, so at times like these I prefer to sit on my hands and wait for the market to show its hand before committing precious investment capital.  As such, I thought the latest from one of my favorite technicians, Tom McLellan would keep readers occupied until we have clarity on market direction. Readers should recognize Tom's name as I have used his teaching many times in the past so he requires no introduction. He always has an interesting take on topics and this one is no different. It’s a good read on savings rate and stock prices. Enjoy!

Bad News: People Are Saving More

Savers are masochists.  They deny themselves immediate gratification for the hope of future reward.  And more interestingly, they do this behavior more when the rewards are taken away.

Anyone who ever took Psychology 101 learned about what lab rats will do if you take away the food pellets.  They stop pressing the lever, and they lose interest.  But savers do not behave that way.  The Fed has taken away the incentive for Americans to be savers, through its Zero Interest Rate Policy, or ZIRP.  In response, people are saving more.  Go figure. 

During the 1960s and 1970s, when inflation was running ahead of interest rates, Americans displayed a rising rate of savings as a percentage of personal income.  They did this even though they were not adequately rewarded for that savings behavior.  Their savings lost value via inflation faster than it was made up for with interest income, which Congress naturally taxed and thus made the reward value even lower.  But they kept on doing it more and more anyway.

When money market funds were created in the mid-1970s, Americans were suddenly confronted with the opportunity to earn a more appropriate reward for deferring their compensation, and for instead saving their money.  But curiously, Americans did not do as B.F. Skinner would have suggested they would do.  They did not increase their savings behavior in response to the greater reward for doing so.  Instead, they started a long downward trend in the savings rate, saving less and less of their income even though they could earn more in real terms for doing so.  And that downward trend in the savings rate just happened to coincide with a secular bull market for stock prices.  

But since 2005 we are seeing the monthly savings rate data show an upward trend.  This change in behavior makes complete sense.  Baby Boomers are facing imminent retirement, and thus they are mounting a last-minute campaign to save up enough to live off of without eating cat food, or turning to their formerly helicoptered children for support.  At the same time, the “Millennials” or “Echo-Boomers” are just now moving out of their parents’ basements, and have not yet become a major economic force.  So the Echo-Boomers are not yet making up in consumption for what their parents are saving.  

In one way, it makes sense for individuals to save more even though they are rewarded less for doing so.  They know that they need to have a big enough pile to live off of, irrespective of how much interest they make off of that pile.  The loss of interest income (reward) acts as a perverse incentive to engage in that saving behavior even more.  It is as if a rat somehow knows that the food pellets are not going to be there in the future, and so rather than eating them, he “squirrels” them away in a safe place to eat later.  Hey, who says I cannot have mixed rodent metaphors?

One problem is that episodes of this behavior of people saving more tend to be associated with negative growth rate periods for stock prices.  That’s a bummer for stock market bulls.  So what you should do as a prudent bullish rat is to save your own food pellets while simultaneously encouraging your neighbors to eat all of theirs, and thus make the stock market indices rise.  Good luck with that plan. 

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.