Data Driven

Since late last year, the bond market has gone from expecting 2-3 Fed rate increases for 2019, to now expecting 3-4 rate cuts. How quickly things changed. Like most every other big change, the experts failed to see it coming and the majority got it wrong. Accurately and consistently forecasting the future is impossible and why one should only pay attention to price. It’s never wrong.

As you can see in the 20-year treasury bond ETF, TLT below, its price has risen ~20% from last October’s support test to last week’s prior-high resistance challenge. That’s a big move. A 20% move in bonds usually takes 3-5 years, not 7 months. As of now this move is nothing more than a reflection in the market’s expectation of those rate cuts. It should come as no surprise the places TLT found support/resistance (hint …. look left). But now that last week’s attempt to move above was rejected, as investors, we all want to know what’s in store for the future. 

The cop-out (but honest) answer is no one knows, especially me. But I do know that as a minimum I would expect the bond rally to cool off here and consolidate before they show their hand. Continued weakening in global economic indicators would likely push bonds well beyond the upside breakout level.  A trade agreement and economic expansion would bring a high probability they retest the green support line once again. The problem with trying to determine the highest probability next move is the fact treasury (sovereign) bonds are driven less by the market and more by Central Bank action. And unless you are on their email list or can tweet your frustration with their leader and threaten firing him, you should be prepared for anything and in the words of the FED, be “data driven”.

Don’t Laugh, it’s Possible

I can hear the giggles and scoffing starting already. It always does when you bring up the idea of commodity prices rising. Every discussion for the past umpteen years that we have had regarding inflation being something investors need to watch out for has been the little boy crying wolf. Will this post be just one more added to the list of failed breakouts in the commodity space? Could be, but this post is not about all commodities, just corn.

Taking a look at the long-term (15 years) chart of corn below you can see it has a tendency to base and then rise strongly. As we have learned, it’s not just corn that does this, it is every investment. Looking to the far, left-hand side of the chart you can see the price of corn went sideways for more than 2-years before it broke out and climbed more than 310% before peaking in the middle of 2008. Once again in late 2008, corn started to consolidate sideways, lasting for 2-years before finally breaking out and climbing more than 175%, peaking in the middle of 2012. Fast forward to current and we see a huge, 5+ year base that corn broke out from. Notice how in all cases, buying volume (lower pane) spiked at the breakout levels which is the confirmation of the breakout and the potential for healthy gains.

While the first upside target based upon the rectangle pattern breakout is up at T1, I would assume the next run in corn could be as large and long as those seen in the past. Because the current base is more than 2x the prior two, a 1.5-year climb with gains exceeding 100% are conceivable.

Is it Time for Gold to Shine?

Gold had been in a 6-year downtrend since peaking in 2011 until breaking free in August 2017. Just because something ceases being in a downtrend does not make it a good investment because it could, like gold did, consolidate for many months or years after breaking its downtrend. But downtrends, followed by consolidations are usually the sign of a new uptrend …. You just need to be patient, wait for the opportunity to come to you and dont chase.. Oh, did I mention the need for patience? In the case of gold, it is on that cusp as you can see in the chart below.

For investors, gold becomes an interesting asset to own if it breaks above its 1370 resistance (neckline) as its first upside target is at T1, around $1600. Those astute observes will also notice in the bottom pane, the increase in green (accumulation) volume bars is the confirmation we want to see if it eventually breaks out.  With global stocks stuck in a sideways consolidation (at least for now), finding a non-correlated asset that is potentially embarking on a new uptrend is all we could ask for.

Gauging Risk

I find it helpful to regularly assess global investors willingness to take on risk (it’s a kind of “follow the money” check). Why?  When the there is little perceived risk by investors, markets tend to trend higher and this is reflected when you see the riskiest investments outperforming. Of course, when risk is increasing the first things that get sold are those assets with the greatest risk. As such, investing in these instruments can be a blessing and a curse. In the world of bonds, the riskiest investment is considered to be junk or high-yield fixed income securities. For stocks you would need to look no further than the frontier markets due to their extreme illiquidity. Closely monitoring those investments to access risk in the two major asset classes can act as an early warning of potential future trouble …. a proverbial “canary in the coal mine”.

For those that don’t know, frontier markets have been defined as a developing country which is more developed than the least developed countries, but too small, risky, or illiquid to be generally considered an emerging market. Not perfectly clear or well defined as you will find situations where there is no agreement about which category a specific country fits in to. But it does provide a weak framework and definition but leaves it open to individual interpretation. There are a few ETF’s that invest solely in these markets, my preferred proxy, the biggest and most liquid is FM.

Looking at the current chart of FM, you can see it declined for the majority of 2018, losing more than 25% and like the rest of global stocks, found a bottom on Christmas eve.  Since that time, they rose for 7 weeks, climbing more 13%, consolidated for 13 weeks and eventually busted a move higher. As you can see, that consolidation created a bull flag pattern which points to a target just below Jan 2018’s highs. This tells me that, at least for now, global risk (and most importantly the desire for equities) is still on and we have not yet topped out.

I would be remiss if i didn’t point out the very strong similarities the current price path is following as compared to the one that began in July 2014. While the markets don’t necessarily repeat, they do rhyme.  

It’s All About the Base

Understanding market structure is nothing more than realizing markets do only two things, they trend or they consolidate. When trending the buyers are clearly in charge (assuming it is trending upwards otherwise it is the sellers who are in control). Consolidations or basing is where bulls and bears are in balance. Not perfect equilibrium mind you, but rather a place where neither has control and price action reflects the back and forth choppy fight. We are interested in bases is because eventually they into a new trend and a potential home for cash awaiting deployment.

I wanted to bring to light a couple of current client account holding examples (those that hold individual stocks) where basing took place over a period of time (8-10 weeks) and broke out strongly higher this past week. The first is AMD

The current run was started back at the end of January when the price gapped higher as it blew out the doors on its earnings report. You can see the big (institutional) buying volume (bottom pane) that initially stepped in caused the gap. Since then, price has been trending higher but for the past 43 days has been trading sideways, forming a nice cup and handle pattern. Big buying volume once again stepped up and pushed the price higher, out of the base. Looks to me it wants to test prior highs from September of last year. Notice also that after the earnings gap, the (green) 50 day moving average has acted as support. This is quite typical of momentum stocks.

The next stock, Mongo db, has a similar look to AMD. It too, gapped higher on excellent earnings (note institutional buying volume in bottom pane), moved strongly higher and then began a new base. It took 53 days of sideways “no action” before it broke out to the upside last Friday, climbing more than 15% in a day (check the buying volume confirmation in the lower pane). Like AMD it looks like it wants to go higher, maybe much higher as it has broken out to new, all-time highs from that same cup and handle pattern.

While frustrating, basing action is critical as it unwinds frothy, overbought conditions and allows buyers a chance to take a breather and round up the troops for the next push higher. It’s important to remember, not all stocks move higher after consolidation. But your probability of investment selection success can be improved by looking for those companies who produce outperformance in earnings (and revenue) and confirmed with high volume buying participation.

So remember, when investing, it’s all about the base. No trouble.

Sorry Meghan!