Your Turn

Those long-term followers know I use ratio charts as a part of my process, mostly to help determine where best to allocate investment capital. As with investment prices, trends persist when it comes to outperformance (ratios). The chart below I call “Risk On” is a ratio of the US SP500 stock index performance to US 30-year treasury bonds and its message helps define current risk levels. If the ratio is rising, risk is low and you have achieved (and will likely continue due to trend persistence) the best return by investing in US stocks only. If the ratio is falling, risk is elevated and bonds are out-performing.

With a quick glance, what should be immediately noticeable is the ratio broke below its rising uptrend support line in November of last year. This occurred at the same time when RSI momentum (upper pane) diverged (both short term and longer term) with the ratio warning of an increase in risk and possible trend change. From that point the ratio was crushed with the strong year-end selloff in stocks.

With stocks rebounding strongly from their massively oversold condition the ratio has, as you would expect, mirrored its move higher. Uninspiringly, the ratio closed out yesterday still below its falling 200-day moving average and has yet to make its first higher low. Looking left we see that the ratio is about the same place it was 12 months ago telling us that stocks and bonds have had a comparative return. Now what?

Closing out this post right here intentionally not providing a summarization or point to the post, I am wondering how you would interpret the charts message? Pile in to stocks gunz a blazin’? Stay on the sidelines in the safety of bonds and let the dust settle? or something in between?  I’d love to hear your thoughts and opinions.

Advance Decline Line’s Message

The Advance-Decline has proven itself over the years and as such is an important tool when assessing the health of a market. Like all indicators, its never always correct and why it should be used in a weight-of-the-evidence approach.

The Advance-Decline Line (AD Line) is a breadth indicator based on Net Advances, which is the number of advancing stocks less the number of declining stocks. Net Advances is positive when advances exceed declines and negative when declines exceed advances. The AD Line is a cumulative measure of Net Advances. It rises when Net Advances is positive and falls when Net Advances is negative. When comparing the AD Line against the index, the AD Line should confirm an advance or a decline with similar movements. Divergences in the AD Line vs index can signal a potential reversal and worthy of an investor’s attention.

Taking a look at the AD line in 2015 during what we now know turned out to be just a (~19%) correction in a bull uptrend instead of a change in trend, the AD line in the upper pane was still rising, while the stock index in the lower pane was declining. This is an excellent example of bullish divergence …. we all know what happened after the fact (the resumption of the bull market).

Fast forward to last December’s 20% decline, you can see that the AD line again diverged from the price of the index just like it did in 2015 hinting to expect a continuation of the bullish uptrend instead of a reversal.

As always, price never goes straight up and we should expect the normal market ebb and flow based upon investors whims especially now as we are so overbought, but any shallow pullback will be viewed as a opportunity to put risk capital back to work, if not already complete.

US Stock Market Update Video

A quick video highlighting a longer perspective of the US stock market.

https://youtu.be/MBfmvgx4P9I

Don’t Ignore This Opportunity

Emerging market equities appear to have turned a corner from their recent intermediate term downtrend. In the chart below of the emerging markets stock ETF, EEM, you can see it declined almost 25% since it peaked last March. Since finding a bottom in late October the index began to rally at the same time US stocks were falling, reflecting relative strength. Additionally, RSI momentum has moved from being oversold to approaching its first overbought condition since January of last year, something the EEM bulls want to see. And for those, like myself who want confirmation of a trend change instead of trying to pick bottoms, the index has formed a series of higher highs and higher lows, the final signal it’s time to commit some investment capital.

Even though a bottom may be established in any investment opportunity there is no reason to invest in it unless it is going to outperform the current alternative leader. The winner of your investment capital war should be the one that will provide the greatest gains, right? In the bottom pane is a ratio of EEM to SP500. A quick refresher is when this ratio is falling EEM is underperforming and telling you that the SP500 deserves your investment capital. If, on the other hand the ratio line is rising, the alternative is true identifying the emerging markets as the better choice. As you can see the ratio began to bottom and formed a very nice rounded saucer pattern indicating a change in direction and shows EEM is outperforming on a relative basis the SP500.

The weight of the information the chart presents a strong enough argument for me to invest, how about you?

36 Rolls of Toilet Paper

Where is the only place a normal person feels good about spending $30 to purchase enough toilet paper to last a year in one visit to a store? Not only do you need an SUV to get the bundle home, you need a small condominium in extra space in your home order to have enough room to store them. Of course, I must be talking about Costco.

Because the current rally has gone so far so fast, a normal market would be ripe for a pullback. As such, I continue to look for some good shorting idea setups that would provide some gains and portfolio protection if/when the broad market takes a breather. Last week’s EFA short idea was stopped out with a small 1.5% loss.

In the daily chart of Costco, COST, below, the $216-$217 level has been very important over the last 6 months and as such would be expected to continue to be. Before COST finally broke below that level in early December, looking left we can see it acted as support 5 previous times. We know that once a level was support, broken it now becomes resistance which is exactly what we see happening. As the shares of Costco have risen off the December 24th bottom it is starting to struggle to continue its move higher the closer it gets to that resistance zone.  Notice also, how this same resistance coincides exactly with where the rising (red) 200 day moving average and falling (green) 50 day moving average meet adding more importance to that level. With price below this confluence of resistances and struggling, I am looking for COST to pull back here.

The best case is it falls, makes a higher low and forms a cup and handle pattern.  This would offer a great long entry for those with investment capital to deploy. Worst case, it falls and retraces the entire move (or more) made since the December bottom. If this were to happen this, too, would present another (even better) long entry. Of course, it will take a much longer time to complete so investors are going to have to be patient. For those short-term traders, taking a short here with a stop just above Tuesday’s 215.5 high offer up another excellent risk reward setup for those that can short and are nimble.