Data suggests more upside

Coming off a weekend of political disappointment, it’s easy to get caught up in the emotions of it all. As I pointed out, the market was due for a pullback, and it got a reason to. We can “beat a dead horse” and dissect all of the “what-if” scenarios and implications of the failure. But none of this will be fruitful for your investment decisions. We know that pullbacks and corrections are an inevitable part of investing. And once in awhile we get a major decline, usually due to a recession. The key question is does the data suggest a business cycle peak?

The short answer is no.

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Consumer confidence numbers just came out at a high not seen since November 2000.

Small business optimism

Scott Grannis points out that Small Business Optimism has soared post election and is near all time highs.

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Earnings growth is finally back and is projected to be around 9-11% for 2017. This would be the largest annual increase in earnings since 2011. And this doesn’t even factor in the potential for tax reform and repatriation.

And interest rates are still very low. The earnings yield on the S&P 500 is currently 5.59%, while the 10 year treasury bond yield sits at 2.38%. Even the Fed’s overly optimistic projection suggests the real Federal Funds rate won’t even turn positive until another two years or so. So, even though valuations are on the high side and interest rates have risen quite a bit post elections, stocks still present an attractive risk premium.

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An interesting chart to follow going forward is the ten year yield. Post election the 10 year yield has risen on the assumption of pro-growth policies of the new administration. Since then a trading range between 2.3% and 2.62% has been formed. An upside breakout suggests all is clear, while a breakdown suggests that more of the President’s agenda may be in jeopardy.

Time will tell. But for now, things are looking pretty good to me. But I parse this by saying we’re probably closer to the end of the bull market, than we are to the beginning. The stock market and the economy don’t always correlate. We’ve had great performance in stocks over the last 8 years, while the economy largely under-performed. I wouldn’t be surprised if, going forward, we experience a situation where the economy starts to outperform, while stock performance slows down to an eventual crawl.

The great thing about diversification and asset allocation is that we don’t have to be prophetic. We stick to our strategy and re-balance when necessary. It’s that simple, but certainly not easy.

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Global markets rally, small caps lag behind…

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Three out of the four major market averages pushed above their 200 day moving average during last week’s rally. Meanwhile the Russell 2000, or small caps index, has lagged behind and is still about 5% away from its 200 day (red line).

However it looks like the Russell is in a bull flag pattern, with two higher lows (1135 and 1144) and two highs at 1169. A break above 1169 would confirm this pattern and likely send the Russell above the prior swing high at 1193 and possibly up to the 200 day at 1215.

r2kA closer look at price action shows the trendline coming in around 1150. A break below the trend line would invalidate the pattern and setup for some more downside.

In totality it’s been an amazing run off the late September lows. The S+P 500 has gained about 10% just in the last 2-3 weeks. And even though there bound to be a temporary break or pause at some point in the near future, new bull market highs look inevitable.

Apple reports earnings tomorrow and the Fed’s FOMC statement on Wednesday should keep investors busy.

Want to learn how to trade and analyze the markets? Whether you’re a day/swing trader or investor wanting to learn how to analyze trends in the financial markets, there is something in The Trading Playbook for everyone. 

Pullback finds short term support…

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In last week’s update post we talked about the confluence of short term support near the 1900 level on the S+P 500 and a projected downside target of 1908 was given. That proved to be correct as the S+P 500 put in a low this week of 1904.78 and then proceeded to finish the week with a rally over one percent on Friday.

The daily chart above shows how the S+P 500 has now matched the 83 point pullback experienced in April. And I believe now that the risk-reward (at least in the short term) favors the long side for the time being.

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Along with the confluence of support in the S+P 500, the Dow Jones Industrial Average ran into it’s own support, that being in the form of it’s 200 day moving average (as depicted in the chart above). I believe the confluence of these key technical levels makes the probabilities favor at least a larger retracement rally.

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Just how much we should expect? Well I think a first logical target between 1950 and 1960 is most probable. I have included the above chart to explain a little about why I feel this is so. The chart above happens to be a 15 minute chart that highlights this specific pullback. So far we have seen two separate but equal 17 point retraces and two separate but equal 27 point retraces (where we find ourselves now).

Because of the confluence of support that we have mentioned, I believe this retracement will exceed that of the previous ones. A retracement double the size of the previous (or 54 points) is certainly possible. In this case we add 54 points to the swing low this week and we get 1958 as an upside target. This happens to coincide with the 61.8% retracement level of this most current pullback, along with the 50 day moving average.

I must stress that this is only an educated guess, the Intermediate and Long term trends remain bullish so we must give it the benefit of the doubt. The short term trend remains bearish below 1960. Only time will tell if this pullback turns into something more.

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Another thing worth watching will be the S+P 500 advance – decline line. We would like to see any retracement rally in the major averages be accompanied by a rally that takes this market internal reading back above it’s 50 day moving average as well.

Some quick market observations…

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Over the last six months especially, we’ve seen tremendous strength in the cumulative advance decline line. Seeing these continued higher highs on the price chart above, it really shouldn’t come as much of a surprise that most of the broader market has been “grinding” higher as well.

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One of the least talked about, but arguably the most important index is that of the S+P 100. Wikipedia explains it’s significance the best:

“The S&P 100, a subset of the S&P 500, includes 100 leading U.S. stocks with exchange-listed options. Constituents of the S&P 100 are selected for sector balance and represent about 57% of the market capitalization of the S&P 500 and almost 45% of the market capitalization of the U.S. equity markets. The stocks in the S&P 100 tend to be the largest and most established companies in the S&P 500.”

“The average market capitalization (weighted by market capitalization) of the S&P 100 is about twice that of the S&P 500 ($142 bn vs $68 bn as of April 2014). So it is larger than a large-cap index.”

In the long term chart above we now see this index has finally taken out it’s 2007 high. As the traditional S+P 500 index made a new all time high back in early 2013.

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Another observation comes from the Dow Jones Industrial Average and it’s long term trend line above, as denoted in the above chart.

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Taking a closer look at this trend line shows how it has seemed to do a decent job, as the index appears to be having some difficulty in getting and staying above. This could all change in an instant, there are some mixed messages the market has been sending this year. We have pointed out many of them. The likely explanation is a reversion to the mean, or consolidation, after such a tremendous year 2013 was for risk assets. I think it’s prudent to give the dominant trend the benefit of the doubt until it proves otherwise. History tells us there will be a double digit correction at some point. Unfortunately there is just no way for one to know in advance.

For now, these are just a few these that I am watching.

Tesla (TSLA) update

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I know it’s easy to get caught up in the short-term movements of these high-flying momentum stocks, but before one gets overly bearish on Tesla right now, let’s take a look at the bigger picture.

When Tesla’s stock price broke out to new highs we did a pretty good job of projecting a potential resistance point at $270 (Click here to link to post). The eventual swing high came in at $265.

The chart above shows price action in Tesla over the last 18 months or so. In 2013 Tesla’s stock price dropped about $80 points and became the biggest correction for that year. We currently find ourselves in a correction that has approximately matched the size of that 2013 correction of $80 points along with testing possible support at the prior swing high on the daily chart (white horizontal line).

It appears resistance now stands around the $220 level going forward. Tesla is scheduled to report its next quarterly earnings on May 14th. This may all come down to two factors, 1) being actual earnings and forward guidance and 2) overall market trend. But in terms of current short-term price action, this may turn out to be a good entry point.