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Inverted Yield Curve

Apr 1

Inverted Yield Curve

The stock market traded in a narrow range this past week as the yield curve inverted, which many on Wall Street view as a harbinger of a looming recession. Others on Wall Street sometime observe that the history of inverted yield curves is one of predicting eight of the last five recessions! An inverted yield curve is defined as long term interest rates falling below short term rates, which suggests deflationary pressures down the road, which most translate as a recession looming a few months into the future. I am in the business of objective measurements of the strength, or weakness, in the supply and demand for stocks vis-à-vis decades of history, as predicting the future is almost always an exercise in futility, which can be very expensive in the arena of the stock market.

TATY – THE BIG PICTURE STRATEGIC INDICATOR

Last week’s update mentioned that there was a subtle, but growing negative divergence in the tops of TATY, shown by the down sloping aqua line on the chart above. TATY is a strategic indicator, whose measurements of supply and demand are helpful in determining, if the investment environment is favorable, or if rising risks are beginning to cast a shadow resulting in an unfavorable environment for stocks. Obviously during periods when supply is outstripping demand, a prudent investor would want to scale back their exposure to stocks, and conversely during favorable periods an investor would want to be invested to the maximum exposure allowed by their appropriate asset allocation. Asset allocation guidelines are determined by a number of factors like age, risk tolerance, and so on. At the moment there is a persistent negative divergence growing in this indicator, which is understandable given the age of the bull trend. However, this negative divergence has not yet reached a critical level, but it is far enough along to signal the potential for a more volatile investment environment ahead.

So when will TATY flash a warning that risks have grown to a level, which would compel prudent investors to consider scaling back their equity exposure to the stock market? The wispy and gossamer like euphoria attendant at major tops is often pierced by a sharp break in the stock market, which is then followed by a last gasp rally back toward the highs. This kind of price break can happen at any price level, but in terms of the indicator it shows up as a break into the caution zone surrounding the 115-125 level. I call this the “Big Chill”, as giddy and often highly leveraged investors get touched up enough to give them a good dose of sobriety. Having been chastened by the sharp price break, these usually institutional investors trading in huge size become more cautious on the next rally. This shows up in the indicator as a rally, which is unable to levitate itself at its previous rate resulting in a weak rally in the indicator, which is destined to fail in, or near the red zone surrounding the 140 level. At this point prudent investors should take the warning that a major top may have formed, and then scale back their exposure to equities to “sleep at night” levels. Is this indicator perfect? Well certainly not, no indicator is perfect, but this one is the most consistently accurate major top indicator I’ve found in decades of searching. And, please notice that the ”Big Chill” can occur at any price level, but the indicator tends to do its same gymnastics over and over unchanged, which is its significant value.

Risk management is all about determining where the tipping point is on an objective scale of risks monitoring the lost opportunity costs of not being in stocks, versus where the market may be on the risk scale of being trapped in a devastating bear market for equities. Successful investing is all about risk management, and TATY has an outstanding record of defining when it is time to risk the costs of lost opportunity over the more significant and compelling costs of being trapped in a big bear. In an arena where “perfect” is not an option, I’ll take an outstanding record of accuracy every time. Obviously, currently no “Big Chill” event has occurred, but the growing negative divergence is a sign the next one may happen sooner rather than later?

SAMMY —  THE FAMILY OF NEXT GENERATION TACTICAL INDICATORS

SAMMY, a representative for a next generation family of supply and demand indicators, is shown above with SPXL, and below with SPXL and 3x Leverage overlaid. SAMMY excels at helping execute intermediate trades, which tend to occur 5-8 times a year, sometimes more, depending on a number of factors. I’ve determined that taking more of these intermediate types of trades makes sense in an environment of the lowest income tax rates in decades. SAMMY will likely signal more tactical trades than we actually take, because I never trade just on one indicator alone, no matter how accurate. I have confirming criteria, which must be present to complete the process necessary to execute SAMMY trades. The confirming criteria circulates around the premium/discount indicator signaling a fleeting discount to “value” exists in addition to SAMMY issuing a signal.

SAMMY issued two buy signals recently, which would have worked out fine for SPXL, but not so much for VOO, the non-leveraged S&P-500 ETF, which is more appropriate for risk adverse clients (SPXL is only traded in my personal account, and some family accounts). The slower moving VOO is best employed for client trades, when both SAMMY, and the premium/discount indicator flash daily, or even better, weekly signals. In any case, I’m glad to see SAMMY continue to issue extremely accurate signals, which any professional futures trader would execute immediately, I want to see a high level of accuracy, even if the signal is not confirmed by other indicators, and so far so good. Over time I would expect this next generation family of indicators, confirmed by other indicators, to potentially be an important factor in significantly enhancing client wealth within reasonable risk tolerances.

THE BOTTOM LINE

The bull trend is showing signs of fatigue, which has not reached a critical level according to an array of supply and demand indicators. So, for the time being we will hold our current longs, and look to add to them, if presented with a low risk entry to put excess cash to work. Note to clients with legacy stock holdings, I’ve trimmed laggard stock and mutual positions into strength recently in order to take advantage of better opportunities as they may appear.

 

DISCLAIMER: Alpha Wealth Strategies, LLC (AWS), and/ or Optimist Capital LLC, does not guarantee the accuracy and completeness of this report, nor is any liability assumed for any loss that may result from reliance by any person upon such information. The information and opinions contained herein are subject to change without notice and are for general information only. The data used for this report is from sources deemed to be reliable, but is not guaranteed for accuracy. Past performance is not a guide or guarantee of future performance. Alpha Wealth Strategies, LLC, and/or Optimist Capital LLC, and any third-party data providers, shall not have any liability for any loss sustained by anyone who relied on this publication’s contents, which is provided “as is.” AWS and Optimist Capital LLC disclaim any and all express or implied warranties, including, but not limited to, any warranties of merchantability, suitability or fitness for a particular purpose or use. Our data and opinions may not be updated as views or information change. Using any graph, chart, formula or other device to assist in deciding which securities to trade or when to trade them presents many difficulties and their effectiveness has significant limitations, including that prior patterns may not repeat themselves continuously or on any particular occasion. In addition, market participants using such devices can impact the market in a way that changes the effectiveness of such device. The information contained in this report may not be published, broadcast, re-written, or otherwise distributed without prior written consent from Alpha Wealth Strategies, LLC and/or Optimist Capital LLC.

Regards,

Gregory H. Adams

Senior Portfolio Manager

Mar 25

Intermediate Trade?

I’ve returned from my conference with a group of professional investors in Tampa. The presenters shared their best ideas, and supported them with hard evidence generated by the markets themselves. As long time clients know I disdain opinions, even my own, in favor of making investment decisions based upon objective evidence, which is generated only by the markets. Everything else is just confusing, and often contradictory, noise. My thanks to all the presenters for sharing their work.

Recent updates have made the case that investors should be prepared to experience rising volatility as the calendar turns toward the election. This is not just a casual observation made because an election looms on the horizon. There are subtle changes afoot in a number of supply and demand indicators, which are hinting that the long period of relatively low volatility is beginning to give way to a more volatile investment environment. Interestingly enough, one presenter at my conference this weekend added some detail as to why this may be the case using metrics from his own discipline.

The supply and demand indicator, TATY, shown above in yellow, has begun to display signs of waning strength in the demand powering the stock market. TATY is a strategic indicator, which provides measurements that are key in determining, if the investment environment favors significant exposure to equities in a client’s portfolio, or if market risks have risen to danger levels, which would compel a prudent investor to scale back their equity exposure. This indicator is always shown in these updates in weekly chart format, as this is the most accurate format for this “big picture” indicator.

This week you will notice that I’ve drawn an aqua colored line across the tops of TATY, which on the chart appears as a downward sloping line indicating that this measurement of supply and demand for equities is signaling a creeping shift toward supply over demand. This change has not yet reached critical levels, but if this trend continues, then an assault on new all-time highs may become increasingly more difficult. Please remember an excursion in this indicator into the caution zone surrounding the 115-125 level followed by a laboring, and failing, rally back toward the red zone surrounding the 140 level would trigger a bear market warning signal. Obviously such a development may take several weeks given that TATY is a weekly generated indicator. TATY recorded its lowest close Friday at 141, since this leg of the rally began back on December 26, 2018.

Strong bull trends tend to paint out bottoms in this indicator in, or near the red zone, and tops around the pale blue line shown at the 160 level. So for now the developing negative divergence between the price, and the declining tops of the indicator, are not critical. However, should the divergence continue to linger, and grow even more negative, then investors counting on a continuing strong bull trend would likely be compelled to consider taking profits on intermediate long trades sooner rather than later. Obviously, should the indicator actually dial up a bear warning, then prudent investors may be compelled to option for the risks implied by scaling back their equity exposure, potential lost opportunity risks, to the more urgent, and perhaps more compelling, risk analysis that a devastating bear trend may be at hand, or potentially resuming from the initial leg down dating to the fall of 2018. This situation is often referred to as a bull trap.

SAMMY is a representative of a family of next generation tactical supply and demand indicators, and is shown above in daily chart format. I consider a less than weekly chart format to contain so much noise as to render some of their value diminished. However, intermediate range trading requires than investors have accurate indicators, which retain much of their effectiveness in a daily format. Modern markets have become dominated by large institutions doing trading strategies powered by computerized trading algorithms and derivatives. And, this environment moves much too quickly for decisions based only on weekly indicators, regardless of their record of market noise reduction. SAMMY has proven this family of indicators can be effective at early detection of institutions reversing their positions at BOTTOMS.

Derivatives are often created with leveraged instruments, so even deep pocket institutions must quickly reverse their losing positions, as their size does not give them immunity to how leverage quickly escalates their losses. And, institutions tend to act like fish in a school of fish, which amazingly all change direction quickly and at the same time. My next generation supply and demand indicators are an attempt to make these leveraged and maximum sized institutional position reversals stand out graphically, so that we can benefit early from detecting a change in an intermediate trend as it is happening.

However, most indicators are failures at effectively identifying tops, and the SAMMY family of indicators share that weakness. In all my decades of studying the major topping process, I have failed to find any indicator better than TATY at identifying, when the euphoric and gossamer like environment at tops, has turned so dangerous that the risk/reward ratio compels prudent investors to scale back equity exposure. Until we reach those kinds of objectively measurable conditions, the application of tactical trading tools like SAMMY holds out the possibility of enhancing overall performance within reasonable risk tolerances. SAMMY is shown above in daily format in the second chart alone, then in the third below with SPXL, a 3X leveraged S&P-500 ETF, overlaid and finally with some visual aids included.

Although the previous intermediate trade setup in early March failed to match all our criteria for execution, SAMMY did clearly show the critical shift when large institutions reverse positions. You will note that the “body” of the indicator went “depasser”, a French word for “overshoot”, when it painted completely below the lower red Bollinger Band (also see vertical blue line). This is a surrogate for an exhausted sellers alert, which was then followed by signs of resurgent demand, as the next whole “body of the candle bar painted completely above the lower Bollinger Band. As Paul Desmond often observed: “Exhausted sellers alone cannot confirm a bottom, there must also be evidence of resurgent demand”. This new indicator provided evidence of both, even though our premium/discount to “value” indicator never reached into the discount zone. This dichotomy makes me wonder if the failure to go into discount to “value” contributed to the brevity of the following rally, which has now begun to be reversed with Friday’s sharp swoon?

Currently, SAMMY has not yet painted a whole “body” candle below the lower Bollinger Band, but such a “depasser” event would be an early warning to be on the alert for a new intermediate trade buying opportunity. I’ll not repeat here all the steps we would like to see for a new intermediate trade opportunity setup, but I’ve included below a previous update outlining these steps. The steps have not changed, as when they appear the odds of executing an intermediate, or longer term, low risk trade entry are substantial.

THE BOTTOM LINE

The bottom line is the potential for a more volatile investing environment is beginning to be confirmed by objective measures of the balance of supply and demand. Such a change in the environment will likely result in opportunities to initiate intermediate trades to enhance overall performance with relatively reasonable levels of risks. However, investors will need to adjust to a more volatile investing environment, as after months of relatively low volatility the shift to volatility may become uncomfortable for some clients, but not for Alexander and I, because for us more volatility equals more frequent opportunities.

Mar 19

Finding Opportunity In The Danger Zone

Last week’s update recognized that a low risk buying opportunity may have been developing, and outlined the tactics to be employed in the event the budding opportunity actually materialized. There were three elements required to trigger a purchase of enough VOO, the low maintenance cost Vanguard S&P-500 ETF, to soak up any excess cash on hand in client accounts. Unfortunately, the brief decline failed to reach even the most minimal price target, and also failed to produce enough selling pressure to push the premium/discount indicator into the discount to “value” zone. However, the next generation supply and demand tactical indicator, “SAMMY”, was triggered, and the rally of the past week followed the signal higher. The S&P-500 now rest only four percent below its all-time high at 2941, but is still in the resistance zone mentioned frequently in these weekly market updates.

So far the rally has continued to do what it had to do to confirm the balance of supply and demand remains sufficient to sustain the price by painting out higher highs, and higher lows both in the price, and an array of indicators. TATY, a supply and demand indicator (See Attachment Above), touched new highs this past week, and continues to find support in the red zone surrounding the 140 level. It would likely take an excursion of the indicator into, or near, the caution zone surrounding the 115-125 level, followed by a failing rally back toward the red zone, to signal the stock market balance of supply and demand was at peril of not being able to continue to sustain this leg higher.

 

TATY is a weekly plotted indicator, its most accurate format, so obviously any developments in the negative may take some time to paint out another bear warning. TATY has an outstanding record of warning, when the ratio of risks to reward have risen to levels, which must compel prudent investors to consider scaling back some exposure to equities. The odds are TATY may become critical in determining, if the aging bull trend still lives, or if a large bear market began in October 2018, and the current rally is a form of a “Siren’s Song” imbedded in a huge bear trap for unsophisticated investors? Obviously the stock market has arrived at an extremely important juncture, which will demand critical strategic analysis followed by the application of successful, and likely courageous tactics to enhance, or protect client wealth as the case may turn out to be.

So, the bottom line is that the rally dating from the December 24 low is not yet signaling that it is at peril of rolling over into a resumption of a larger bear market. However, the lack of a substantial consolidation (digestion) of the recent sharp gains may imply a short covering type melt up in the price, as under-invested money managers rush to chase the re-emerging bull trend, could be tardy in developing due to the current overbought conditions. Resistance zones, danger zones if you will, are often tested before being bested. So, the question of a new leg up in an ongoing bull market, or a bear trap before resumption of a larger bear market dating to October 2018, remains an open one awaiting more clues.

Investors should be prepared for an increasingly volatile market environment from now until the election. Bull, or bear market, matters not to Alexander and I, as our records are evidence that we have the requisite proprietary tools, experience, conviction and courage necessary to overcome the challenges implied by a bull or bear, but a bear would provide the most opportunities, because of the attendant frequent excursions of the price into the zone of discount to “value”. Buying “value” at a substantial discount is almost always a winning strategy!

Investors in our ETF Model likely earned a dividend Friday on our VOO positions purchased last year at this time, as the VOO ETF usually goes ex-div around the 15th of the quarter. And, all client positions have now qualified for long term capital gains treatment on our VOO purchase. I expect to maintain some core position in VOO for as long as the strategic (big) picture remains favorable. However, given the lowest income tax rates in my lifetime, due diligence requires me to take advantage of more intermediate trading opportunities than in the past. These kinds of trades, properly planned and executed with our next generation tactical indicators, have the potential to significantly enhance overall performance without creating unreasonable tax consequences.

I’ll be speaking on the topic of major tops in the stock market, and next generation supply and demand indicators, to a group of professional investors in Tampa this coming weekend. I’m looking forward to visiting with friends and colleagues of long standing during this seminar.

Mar 5

Ethics, Disclosure and Your Value

I find myself writing this due to all the problems I see daily in this industry. Optimist Capital was born because I wanted to operate to the highest ethical standard possible and I wanted to protect my clients from bad actors, that they as well as I have had the displeasure of dealing with. We have covered many times the issues of Annuities and Mutual Funds, we won’t revisit those here, rather we are going to dig deeper into Advisors and Firms that do not disclose their inappropriate activities as required or in some case disclose activities which should be signs that you should run away fast.

Let’s start with the disclosure part. The first thing you must do with every Advisor/Broker/CFP etc. is to look them up in brokercheck.finra.org. If they have disclosures read much more closely. It would shock most of you to know, that many of your Advisors have been found to do such horrible things as create documents in your name in order to transact business without your interaction, putting people in investments which are criminal or inappropriate (Annuities are the usual culprit here). In the worst cases we have found folks that have lied to maximize commissions or actually stolen from clients through sales of conflict laden investments. These individuals are still handling money, and still out there selling to their clients or potential clients. We come across them daily.

Though the individual’s disclosures can be readily found, we find that Firms, through ineptitude or just plain criminal actions, do not disclose the inappropriate actions of their employees. There is a specific section within every Investment Advisers’ brochure that states: Disciplinary Information. Often, a firm will employ an individual with disclosures and fails to report in that section about that individual or action.

The second part of this would be Firms that make it clear they care little about you. A great example of this is a fairly well-known firm near our headquarters. They are a Registered Investment Adviser firm like us, and as such are required to treat each client equitably and put each client ahead of themselves. This particular firm grades clients by how much they make from them. If you earn them less than $7500 a year you are labelled a Bronze client, and as such they will only review your assets once a year. Keep in mind, if you hand them up to $750,000 to manage you are the bottom rung to them. Now if you are paying them over $22,000 a year, you are lucky enough to be a Platinum client. A platinum client will get 4 reviews a year. Ask yourself, does that sound appropriate. Oh, and it gets worse, as of this writing they have now created a new tier of Titanium which is $30k or more. This is actually spelled out, clear as day, in their brochure which is public information. Whether this is legal or not is a gray area, however it is clearly unethical. It is an obvious claim that you as a client are less valuable depending on how much they make from you. This is the exact reason commission-based business is a problem, your value is directly tied to how much they make from you.

Here is why this can be a real problem:

  • Let’s say you like working with them and you tell friends.
  • Those friends invest more and become higher tier clients than you.
  • They are now treated better than you, yet this firm would have never received those clients without you. Seems inappropriate right?

Every client should get your equal treatment if you take them on as a client. It is my belief, that if they were a truly ethical firm and they wish to operate this way, they should not take on any clients who earn them less than their top tier. We all know this isn’t going to happen, rather they will likely just change their brochure once they get a whiff of this article and their clients will never know if they are getting equitable treatment or not. Don’t get me started on the fact that they put roughly 50% of their clients assets in Mutual Funds and Annuities, I would love to know how they explain the fees and lockups as in your best interest. It should be no surprise that their performance has been far less than stellar. I have only one questions to ask from this:

Why would anyone ever work with a group like this?

In close, I want full disclosure for everyone, and I want every investor out there to be well informed. I want Equitable treatment for all clients. Read Investment Adviser brochures, look up the firm and individual at brokercheck.finra.org. Run from advisors with disclosures that show clear bad actors and run from firms that don’t disclose those bad actors or make it clear you are only as valuable as what they make from you at this moment in time. We are in the relationship business, long term is the outlook, grading clients by who they are now or how much you make from them now, fails to value who they will become and the relationships they will bring.

You deserve better, you deserve the highest ethics and a manager that is always there for you, that reviews your assets frequently, that keeps you informed and above all else treats you with value regardless of how much you invest.

Mar 4

Test For The Bull Case

The rally off the December 24 low has cleared some math resistance, but is now encountering significant resistance, which has been mentioned previously in these weekly updates, just below the level where the October rally failed at S&P-500 2888. The rally is beginning to appear fatigued, so some further weakness would not be a surprise.

The case has been made that the burden of proof is on the bulls, which must demonstrate the strength to paint out higher highs and higher lows both in the price, and in a series of supply and demand indicators. Now that the rally has reached a zone, where I expect some significant resistance, the bulls will face their most serious challenge to date. TATY, a supply and demand indicator (shown above in yellow with the S&P-500 overlaid in red and blue candle format), began to show signs of struggling this past week, as a minor consolidation in the price has worn on now for seven market days. A generally accepted principal of market analysis states that consolidations are eventually resolved by a resumption of the previous trend, which in the present case was a rally. If the rally does continue, but the indicators begin to  fade instead of confirming, then this leg of the rally will likely be at peril of giving way to at least a correction of the gains to date, or possibly a resumption of the larger bear market, if the rally has been just a counter trend rally as a part of a bigger bear market. Obviously, the bulls have some work to do, and investors must be alert to the possibility that the rally may fail below new all-time highs.

The odds still favor the bulls, but a serious test of the strength, or weakness, in the ever changing balance in supply and demand is now at hand. This expected test will be key in determining, if the bulls really are in control, and the next leg up in a big bull market is still underway. Or, if most financial advisors are about to allow their client’s portfolios to be trapped in a devastating leg down in a continuing large and powerful bear market. Unfortunately, most financial advisors do not even realize that their client’s wealth may be at significant risks late, or soon. I would prefer to see the re-appearance of the big bear market, as we have the experience and proprietary tools to take advantage of the numerous discounts to “value” generated by the violent vortex of a big bear trend, and swift velocity at which prices move during the panic and chaos. So a re-appearance of a big bear leg down would be an opportunity from our point of view, and not a dreaded disaster. Either bull or bear, from now until the next election will be a time for a high level of vigilance, and a time to trust our preparation, experience, and supply and demand tools.

The bottom line is the bulls are facing their most significant test since the December 24, 2018 low, and for the odds to continue to favor the bulls both the price, and a series of supply and demand indicators, must continue to paint out higher highs and higher lows. Probabilities are not static, and the expected test immediately ahead will likely move the probabilities on the risk scale. The challenges ahead can be turned into opportunities for those armed with the right experience and market analysis tools, and the courage to properly apply them for the benefit of our clients and their wealth.

 

Optimist Capital

Phone: 561-771-8077

Toll Free: 833-585-8285

Fax: 561-771-1145

www.optimistcap.com

Feb 25

Next Generation Supply And Demand Indicators

I am doing a presentation to a group of professional investors on March 23rd in Tampa. I will be speaking on how major tops form in the stock market, and I will also be introducing my next generation of supply and demand indicators. These prototype indicators have been under development of many months, and are now being put into service after extensive testing. The final version of this new family of indicators have been locating intermediate bottoms in the S&P-500 with extraordinary accuracy, but unfortunately have not demonstrated any improvement over existing indicators in terms of locating exhaustion tops.

I expect this new family of indicators to enhance our opportunities for profitable trades due to their high degree of accuracy in locating intermediate bottoms. To the best of my knowledge, no other analysts have combined NYSE based indicators with modules representing the supply and demand balance for derivatives, which is how I’ve approached the design of these entirely new indicators. Failure to account for the impact of the risk management component of overall supply and demand represented by derivatives would by definition fail to give an accurate picture of the total supply and demand dynamics for stocks. The bottom line for this section is clients are likely to see more trading in their accounts going forward in order to take advantage buy signals being generated by this new family of indicators. While we prefer long term gains due to preferential tax treatment, with tax rates now at historic lows, we expect very few clients will complain about us potentially generating some additional profits from short term gains.

Recent updates have made the case that the probabilities favored a resumption of the previous bull trend, which stalled in October of 2018, and was followed by the decline into the December 24 low. Our updates said that both the S&P-500, and a series of supply and demand indicators, must confirm the bull case by both painting out higher highs and higher lows. So far there have been no higher lows registered on the weekly charts, but on the daily charts, which are rarely posted on client updates, there have clearly been the requisite series of higher highs and higher lows on both the S&P-500, and the indicators. So for the time being, the bull is earning his stripes, and the bull case remains the higher probability. Clients are long index ETFs, and all our positions are profitable, so for now we will continue to hold all our long positions. Clients coming over from competitors, which have individual stock holdings, may see some selling into strength activity in order to roll off the holdings of our competitors strategies, and then get your accounts rolled over into our ETF strategy over time.

The bear case remains the lower probability, but it is still an active consideration until the S&P-500 clears first 2888, and then the previous all-time high at 2941. If the rally touches a new all-time high, and there is evidence of increasing strength in the balance of supply and demand, then prices may be marked up quickly, even in the face of high valuations, as under invested money managers scramble to get fully invested. Under invested money managers sitting out a rally are prone to be fired, so the price zone just above current levels may see some serious activity, if the bull case remains valid. However, I am not sanguine about the length of the negative divergence leading into the October-December decline, which seems too brief for a major top. And, the brevity of the October-December decline remains a troubling issue as well, because taken together the brief negative divergence, and the brevity of the decline, can be construed in some disciplines as just part of a larger bear market. The ongoing larger bear market theory remains a lower probability, but due diligence compels me to not discard it altogether just yet. The weeks ahead will likely prove one of these two probabilities, but for now prudence demands vigilance as winter turns to spring, and spring turns to summer.

 

The bottom line is the stock market is demanding to be treated as being in a renewed bull trend until evidence to the contrary arrives. This means the new indicators now coming into service are even more important than usual, because excess cash will need to be deployed, if the renewed bull trend continues to prove itself. And, deploying excess cash with tactical intermediate trades may potentially enhance overall performance.

 

TATY, a supply and demand indicator, is shown in yellow on the attached chart, and the S&P-500 is shown in red and blue candle format.

Feb 18

A Key Reversal Day Versus A Key S&P-500 Resistance (Danger) Zone

Our last several updates have covered the implications of the two most probable outcomes for the rally off the December 24, 2018 low. In more detail than usual for these brief updates, we made the case that December 24, 2018 was likely a key reversal date to keep in mind going forward, and nothing that has happened since changes any of those observations.

The notion of a key reversal day has now played out along the lines our updates anticipated. So now I want to review the importance of the S&P-500 resistance levels, which were discussed in recent updates, as those are looming as extremely important in terms of increasing client wealth, or protecting it as the market yields more clues about the strength, or weakness, of the underlying supply and demand for stocks going forward. This is NOT going to be some esoteric academic exercise, but a real financial world challenge to position client portfolios properly on the risk spectrum. Failure to execute this drill properly may significantly penalize client wealth in terms of lost opportunity costs, or expose clients to an assault on their accumulated profits, and/or wealth, as a faux rally rolls over into an accelerating, and progressively violent, bear market decline, as hordes of global investors attempt to rush to the safety of cash, when they realize they have been trapped in the recognition phase down in a big bear market.

The first chart above shows that the S&P-500 has now exceeded, by a good margin, the 62% Fibonacci retracement level of the October to December 2018 decline. This is a very positive development, and implies that the S&P-500 2888 resistance level just ahead may be tested next. I thought the rally may need to consolidate its gains before an assault on the S&P-500 2888 level, but with TATY, a supply and demand indicator (See Second Chart below), spiking to 152 this past week, the rally may have enough strength to begin an assault on the S&P-500 2888 level sooner rather than later? Regardless of the timing, the price is now entering what I consider a danger zone, where the bulls must continue to generate supply and demand numbers sufficient to power the rally higher. The probabilities have favored the bull case, and that will continue to be the true as long as both the price, and a series of supply and demand indicators, demonstrate the ability to paint out higher highs and higher lows.

So Gregory what are you going to do with my wealth? The probabilities continue to favor the bull case, so for now we will hold our current long positions, especially since many of those were purchased last year at this time, which means they are beginning to qualify for long term capital gains tax treatment. All my clients have profitable positions, so yes the tax treatment is an important consideration, even though nominal tax rates are now at historically low levels. However, probabilities are subject to change, and should they begin to move in a direction more favorable to the bear case, then prompt action will be required. Why? The next paragraph covers the extreme risks implied by a mature bear market perhaps on the cusp of a swiftly accelerating terminal decline.

I am content to leave market predictions to those, which think the have the tools and skill to be successful at that most risky of endeavors. However, consideration of the worst case for client wealth must always be taken into the calculus by Alexander and I, as a continuing exercise in client due diligence. The perceived danger zone represented roughly by S&P-500 2888 to the previous all-time high at 2941 is where the bull, or bear, case will very likely emerge as a reality. If the bulls continue to generate confirming supply and demand numbers, then the odds of an accelerating rally will increase sharply, as under-invested money managers chase the rally higher. Please note that valuations are meaningless in these situations, because under-invested professional investors are subject to being terminated by their firms for such an error, which are costly to clients in terms of lost opportunity. However, if the bulls fail to generate objective evidence that they are still in control of the market, then the odds will begin to gravitate toward the bear case, and the bear case in this situation represents huge potential risks to investor wealth.

If the danger zone gives way to the next leg down in a very big bear market, then the potential wealth penalty may be applied swiftly, and in unrelenting fashion. If the October to December 2018 decline was just the prologue in a big bear overture, then the next leg down will likely contain a violent vortex of volatility, as panic and mindless program selling become the order of the day. It matters not how good a leader a corporate CEO is, nor the strength of the franchise, nor the strength of the balance sheet when that corporation is a part of an index, which is being sold in size by panicked investors on the global exchanges, or in the futures market. When the program sellers launch their sell algorithms, then selling begets selling, and the selling continues until the bear trend finally exhaust itself. Such is how mature bear markets do business. Thankfully, for the time being the mature bear case remains a lower probability, but still an active probability subject to revision higher.

The bottom line is we got the “tell” of the December 24-26, 2018 key reversal date right, and now the bigger, and much important challenge, is to correctly solve of the resistance (danger) zone conundrum as well. To do so will require us to properly apply our proprietary tools, and all our experience, to a potentially very dangerous situation, and then to have the courage to act adroitly in the best financial interests of our clients. A difficult mission in all aspects, but especially the latter, as most in this challenging business are prone to fail the test of courage at critical moments due to lack of confidence in their methodology and/or preparation.

 

Feb 11

MANAGING RISKS: LOSS OF OPPORTUNITY COSTS VERSUS A BIG BEAR ASSAULT ON WEALTH

Recent updates have been exercises in briefing our clients, and research customers, about the risks associated with bull and bear trends in the stock market. The former involves the implied costs of lost opportunities, and the latter the very significant damage to wealth represented by a mature bear trend during the recognition phase, as countless panicked global investors seek safety by trying to exit the stock market through a very small door, and all at the same time. Bear markets can develop in a multiplicity of ways, but for now we will look at only the most probable. We will save the topic of financial malpractice on the part of too many financial advisors, which unfortunately we discover in the portfolios of potential clients almost weekly, for a later date.

The Bull Case. As previous updates have stated, the holiday shortened market session on December 24, 2018 looms as a key date, both in terms of how we define a reversal day, and how TATY, a supply and demand indicator, has behaved historically following an excursion into its green zone surrounding the 90-100 level. This indicator spiked intraday to 101 on December 24, only one point short of the green zone. The previous ten excursions into the green zone were all followed by new all-time highs, albeit sometimes after a test of the low, so the one point miss on December 24 has positive implications. Following the eruption of demand on December 26, which set a one day Dow point gain record, the stock market has rallied to marginally above a 62% retracement of the decline from the all-time S&P-500 high at 2941 to the low of the leg down at 2347 (See The Chart Above). There is strong resistance at S&P-500 2888, and of course at the previous all-time high at 2941.

For the bull case to remain valid, a series of supply and demand indicators must continue to paint out higher highs and higher lows concurrent with the price doing the same. Should this occur, then at some point under-invested professionals will recognize the bull still lives, and a rush to get invested would likely follow, which would likely cause the price to accelerate higher. Investors positioned defensively in anticipation of a bear leg down would pay a substantial loss of opportunity costs for their error in this scenario. Currently the probabilities favor the bull case, but that could change as the market yields more information about itself, as we approach the resistance zones immediately ahead at S&P-500 2888, and the previous all-time high at S&P-500 2941. The rally off the December 24 low at S&P-500 2347 showed signs of needing to digest its gains this past week, so clients should not be surprised if the stock market settles into a trading range in the days ahead, before a resumption of the rally from the December 24 low.

The Bear Case. Most investors do not realize that a big bear market can make a new all-time high as part of the overall bear trend. I’ve drawn a crude representation of how “irregular” bear markets develop. For illustrative purposes, I’ve attached the bear example to the current chart of the S&P-500 (See Chart Above). The task of bear markets is to fool the majority of investors the majority of the time, as the bear goes about the business of correcting the excesses of the previous bull trend. Bull and bear markets tend to go to extremes as human nature tends to swing between extremes, and at the end of the day it is the perceptions of investors, which drive the price of markets. And, since we human beings tend to emotional extremes, then markets tend to do the same, as a reflection of our emotional journeys as a herd.

The chart above shows the most common Fibonacci retracement levels calculated for the rally off the March 2009 low at S&P-500 666 to the recent all-time high at S&P-500 2941. The October-December decline touched the 25% retracement level. If that leg down is only the prelude in an ongoing big bear market, then the rebound will likely assault new all-time highs before rolling over into a relentless and violent leg down in the big finale to the grand bear overture. Such an event may start with a “newsy” gap down from the territory of new all-time highs, which would likely be followed by a swift and accelerating decline driven by panic, as global investors recognize the mature phase of a big bear market has trapped them at all-time highs. Wealth literally evaporates in this part of a bear market, as panic drives the price swiftly in both directions violently, but mostly down. When a big bear gets down to business, then there is literally no place for equity investors to hide. The last chart above shows some reasonable Fibonacci retracement support levels for the big bear case are S&P-500 2078 (38%), 1808 (50%) and 1539 (62%). The decline could stop anywhere, but these are the popular math levels to watch. Please note that S&P-500 1808 is essentially the February 2016 low, so that one really gets my attention.

The big bear case is a relatively low probability at the moment, but probabilities are not static in the stock market, and as the market yields more information about itself, then the probabilities become subject to change, and perhaps dramatically.

Acceleration. The zone surrounding new all-time S&P-500 highs represents a danger zone in terms potential acceleration in the price up, or down. If the bull trend is real, then the remaining resistance zones at S&P-500 2888, and the previous all-time high at 2941 will be breached, perhaps more easily than currently anticipated? Should this happen, the rush to get fully invested to avoid a substantial loss in terms of opportunity costs may result in a brisk acceleration in the price higher. Under-invested institutional professionals lose their jobs for not being fully invested, or even leveraged during a bull trend. These conditions can lead to investors chasing a bull leg higher, even though the premium to “value” of the price may reach ridiculous levels. Remember the stampede into the internet stocks in the late 1990s, even though some of those stocks did not even have sales let alone earnings! So in the weeks ahead we may see an acceleration higher, even as values assigned to stocks by the market become ridiculous, if the bull case is real.

On the contrary, prices also tend to accelerate in mature bear markets due to recognition. Unfortunately, the acceleration is down, and in the mature bear case more in the mode of a meltdown, due to panic stampede conditions. So what will it be, an acceleration higher or a meltdown? Well given the multiplicity of options available to big bear markets, something other than the two options outlined above may be chosen by the market, but for now we will go with the probabilities and plan around these two strategic outlooks. This means as more information becomes known a tactical plan will be developed to address the emerging resolution of the current conundrum.

The Bottom Line. The odds remain favorable for the bull case, so in the days ahead we will hold our current longs, and possibly add to them should an attractive buy signal develop. An attractive buy signal may develop, if the market begins to digest its recent sharp gains, which could chew up most of February, and possibly into March. We will go with the bull case until it demonstrates it may be failing, at which point the issue of acceleration must be addressed correctly.

TATY, a supply and demand indicator, is the chart above in yellow, and the S&P-500 is shown overlaid in red and blue candles. TATY has found resistance just above the red zone, and may give up some ground, if the market enters a consolidation of its recent gains off the December 24, 2018 low. It will be important for this indicator to form a higher low and recover quickly off that low, to avoid a warning that the rally off the December 24 low is all the market can deliver before the resumption of an ongoing bear leg dating to October. When this indicator stalls out near, or in, the red zone, then the market may be vulnerable to a decline.

 

Vigilance required.

Feb 4

On the Cusp

Recent weekly updates have discussed that Christmas Eve was very likely a key day to remember going forward, as there were a number of important signs on that day, and the following business day, that at least a short term market reversal had taken place. As you may remember, December 24 and the previous couple days, had all three painted out consecutive 80% downside days, which were followed on December 26 with an eruption of demand setting a record for a Dow one day point gain. So this brief period of time bore evidence of exhausted sellers and rejuvenated demand, which in my discipline I’ve applied successfully for years, constituted a market reversal day. TATY, a supply and demand indicator, also spiked intraday on December 24th to 101, just one point shy of the green zone surrounding the 90-100 level, a very rare event. All ten previous excursions into the green zone by TATY, since the 1990s, have been followed by new all-time highs, albeit sometimes after a “retest” of the low. Given the strength of the rally since December 24, a retest of the low looks like a very low probability. So the very short duration (marginal) bear decline is over, and a new leg in the bull stock market is now underway right? Well yes there is some objective evidence that this maybe the case, but given the multiplicity of options for the development of big bear trends, a more insidious and very dangerous option may be afoot as well. Today we will take a look at how the two most probable options may develop vis-à-vis a series of supply and demand indicators. Please remember the two most probable options do not rule out the possibility that something entirely different may develop, such is the nature of bear markets.

First let us take a look at the bull case and the notion that the whiff of panic leading up to the December 24 cathartic type bottom may have birthed a new bull leg to new all-time highs. Recently the events surrounding the December 24 low were investigated with an exhaustive comparison to similar events over the decades. This created a very favorable bull case. With the exception of more marginal positive results, surrounding the uncertainty of war in the 1940 decline, the following weeks and months the stock market went on to post very favorable results, and in some cases dramatic results. Nothing is perfect in this game of probabilities being played by the brightest of the bright, but the research clearly slants the odds in favor of the bull case, at least for the time being. However, for the bull case to continue the newly minted bull leg must continue to prove that demand has the upper hand over supply by painting out higher highs and higher lows, both in the price of the S&P-500, and in a series of supply and demand indicators. And, given that the rally off the December 24 low has now arrived at a very important series of resistance levels, a test of the ability to paint out higher highs and higher lows is now at hand.

The first attachment above shows the decline from the all-time S&P-500 high at 2941 to the December 24 low at 2347. As you may recall, a previous update discussed the work of a 12th century mathematician named Fibonacci, who discovered an important number sequence and ratios, which occur both in nature and the markets. The chart shows that the rally off the December 24 low has now reached the popular 62% retracement level noted in Fibonacci’s work. The implication is that the rally may begin to struggle at this important math resistance level, so from our perspective the test to paint out the first higher low may be at hand? Clients should not be surprised if the fist half or so of February maybe consumed by a listless market, which may trade marginally lower. The problem is the supply and demand indicator, TATY, is once again showing signs of struggling near the red zone surrounding the 140 level, a behavior often associated with the expiration of major tops. So the test ahead is an extremely important one, because remember both the price, and a series of supply and demand indicators, must both paint out higher highs and higher lows. Stay tuned as this important test will very likely chew up a good part of February before a verdict will be issued by the market. So the bottom line for the bull case is the bull is likely to be tested here at the 62% retracement level, and to pass the test for this leg up, both the price and the indicators must paint out higher lows in order for the bull case to remain the highest probable outcome.The bear case makes the next 30-90 days or so a really critical time for investors. The bear case at the moment is the lesser probability, but clients should consider the probabilities to be on a sliding scale and not static. The bear case is subject to moving higher on the scale of probabilities, and perhaps rapidly so. Please take a look at the third attachment, which is the supply and demand indicator, TATY, shown in yellow, and the S&P-500 cash index overlaid in red and blue candle chart format. You will notice immediately that TATY finished the week at 147, a marginal improvement over last week’s 146, but far short of the zone beginning at the 150 level depicting very strong demand. Given the math resistance at the 62% retracement level, and the expected consolidation of the gains from the December low at 2347, some give back in TATY will likely occur coincident with the expected digestion of the recent gains in the price. However, this raises the short term risks given the history of the red zone being where bull trends go to die. Should both the price and the indicators form a higher low in February, or March if tardy, then the next significant resistance is not far down the road at the S&P-500 2888 level, where the previous counter-trend rally failed, and then finally the all-time high at 2941. Given the escalating number of resistance level directly ahead , a more ragged drift higher may be in the offing, if this rally is only part of a larger bear market. The larger bear market option remains a lower probability subject to seeing how the supply and demand equation shifts here on the cusp of what I consider to be a very large and significant danger zone.

Well Gregory that is all fine and good, but please tell me what you intend to do with my wealth! OK here is the very hard reality of dealing with the uncertainties of the stock market. Investors must constantly measure the risks of lost opportunity costs with the very real and instantaneous costs of becoming entrapped in a bear market, particularly a bear market, which has finished its prelude and is about to get down to the business of creating a violent vortex of panic, and the mindless program selling attendant to global investors in panic mode. If the market has not begun a new bull leg, then the prelude for the bear overture is nearing an end. The bear market could re-manifest itself right here, if TATY stalls near the red zone, and then fails to form a higher low along with the price. Alternately, and the more dangerous and insidious option, and bear trends are prone to take the most insidious and destructive path, the market squeaks out a marginal new all-time high, which will end the bear prelude, and investors last chance to escape a steep, relentless and violent decline, which may even begin with a significant gap down on some kind of newsy event. Please remember that the maximum and fastest destruction of investor wealth happens not in the prelude of a bear overture, but in the free fall of the finale, as countless global investors scramble to get through a very small door to safety. The numbers I published recently, based on reasonable Fibonacci projections, was a bear decline of 30-50% from wherever the final high is touched, not a prediction, but objective math applied to the important known price levels created by the market itself.

So here is the bottom line, for now we will keep your portfolios invested, as the bull case remains the most probable . The research is also supported by the history of positive results following a rare intraday TATY excursion into the green zone surrounding the 90-100 level, and for now a one point miss at 101 is close enough to tip the probabilities in favor of the bull case. However, navigating the stock market is not an exercise in getting married to a notion, but one of changing as the probabilities move up and down on the scale of probabilities. If the bull case proves itself, then demand will likely surge, and the resistance zones discussed above will not stop the rally, and once breached the bull will likely accelerate higher, as the under-invested scramble to get fully invested, a situation where he, or she, which hesitates becomes subject to paying an accelerating lost opportunity cost. If on the contrary, the market cannot generate strong and increasing demand, especially in the zone surrounding new all-time highs, then Alexander and I will be compelled to conclude that we prefer exposing clients to the risks of lost opportunity vis-à-vis to the risks attendant to a melt-down type final leg in a large and mature bear market. Remember, when a bear is done with the overture, the finale gets ugly quickly as panic is one of our strongest emotions. Now clients know why this update is entitled “On The Cusp”, because we very likely are!

Optimist Capital

Phone: 561-771-8077

Fax: 561-771-1145

www.optimistcap.com

Jan 28

Into The Danger Zone

The last two updates have been longer than usual in order to brief clients on the most probable paths the stock market has available going forward based on an array of supply and demand indicators. This week’s update will return to a more brief format, as the drill going forward will be to monitor the progress, and probability, that the three pathways outlined previously are still the most likely to emerge, or if conditions are changing and a new option(s) may be emerging.

Almost a year ago now in February and March the stock market took a sudden and swift plunge. Indicators were not warning that a major top was forming, but they did signal that the swift decline was likely an opportunity to put cash to work with relatively low risks. So episodes of panic like decline during that brief correction were used to buy into the stock market, as some indicators were flashing that the price had descended below “value”. Even during bear markets compressing the price below “value” tends to be fleeting opportunities demanding adroit trading. As 2018 progressed the decision to buy was rewarded as the stock market embarked on a slow and steady grind higher. During the slow move higher negative divergences began to build in an array of supply and demand indicators, which eventually resulted in a break in the rally beginning in October, which may have ended completely on Christmas Eve, or a significant leg of a larger ongoing bear market may have ended on the Eve of Christmas. The brevity of the decline suggests it may be only part of something larger.

Major stock market tops are usually tested often enough to give investors time to sell into residual strength, as the gossamer like euphoria attendant with major tops slowly diffuses and then dissipates. Although TATY flashed a classic sell signal in November, I elected to hold our positions purchased in February and March 2018, as the odds of a retest of the all-time S&P 500 high at 2941 seemed to have reasonably good odds of success. A retest of S&P-500 2941 would likely linger into the spring of 2019 giving our positions purchased in 2018 time to collect two more quarters of dividends, and also qualify the purchases for long term capital gains. These are the kinds of challenging market and tax implication decisions you pay a Registered Investment Advisor to make, as opposed to a market letter writer, whose job is to just analyze the market. So now that evidence that the correction may have ended, or at least the first leg in a larger bear market may have ended, the decision to hold our long positions looms as a potentially good one.

A critical period in the stock market lies directly ahead. The events of the spring and summer of 2019 may very well be a dramatic demonstration of why you do not want to try and do at home what Alexander and I do every day. The challenge ahead will be to hold client long positions, or to put new cash to work in the stock market, or conversely prepare for another topping out situation, which would demand maximum protection for client accounts. You see if December 24, 2018 was the end of the correction/bear market, then it is very likely that months of rally lie ahead in a new born bull market, or extension of the previous bull market. On the other hand, if the December 24th low was only the end of a leg down in a larger bear market, then the current rally will fail in the zone just below the all-time S&P-500 high at 2941, or perhaps marginally above it. The difference in the impact upon client wealth could easily be in the range of thirty to fifty percent, if a new bull market was born on December 24th. Why? Read on for an answer.

If the stock market remains in the grip of a large bear market, then the current rally is a counter-trend rally destined to fail in the zone surrounding the all-time S&P-500 high at 2941. Once the rally rolls over, then the bear market will very likely be recognized by increasing numbers of global investors, which at some point will likely tip over into a “recognition” stampede, a violent vortex of mindless program and panic selling. This is how major bear markets do business as they mature. In finance this is something like the “event horizon” in astrophysics, where nothing, not even light, can escape the exponential power of the pull of gravity in a black hole. So if investors posture for the remainder of the bear, and then the market dials up a bull, there will be an immediate problem of how quickly can the tactical positioning error be corrected. Will that be twenty, or more, percent later as the bull accelerates higher driven by under-invested money managers scrambling to buy into the resurging bull trend? Or, on the other hand, if investors position for the newly minted bull, and the market dials up the terminal leg of a large bear, you know the leg containing the violent vortex of mindless program and panic selling, how long will it take to reposition in an effort to escape the remainder of the panic driven decline?

Experience tells me investors, which mis-position their portfolios in the weeks ahead, will be looking at a potential loss of opportunity, or real potential losses in their portfolios of around 30% on the light side, to perhaps 50% on the heavy side. For example, last week’s update showed that one popular Fibonacci target for a retracement of the rally from the March 2009 low at 666 to the all-time high at S&P-500 2941 was the 62% retracement level at S&P-500 1535. If the current rally gives out of gas at a marginal new all-time high as part of a larger bear market, then that S&P-500 Fibonacci target sitting at 1535 falls into the range of a 50% bear plunge. And, here is how bear math works, should that happen, then investors would need a 100% gain just to get back to even! So bull trend or bear trend matters, and it matters most to those over age 50 with less time available to recover from serious losses. Now please do not take this representation of the possible worst case as a prediction, as I do not do predictions. However, Alexander and I must always be aware of the potential worst case in order to protect clients from it. At this point the worst case is a relatively low probability, but statistically large enough for us to brief clients about it. If the probabilities begin to move higher, then (quick?) defensive action will be required.

The bottom line this week is a critical time in the stock market looms ahead as the calendar turns from winter to spring, and then to summer. My advice to investors is do not attempt to do at home what Alexander and I will be doing as the stock market flies “into the danger zone”!

An old Asian saying goes like this: “May you live in interesting times”, and the odds favor the year 2019 being a year of very “interesting times” in the markets.

TATY, a supply and demand indicator, is shown on the attached chart in yellow, and the S&P-500 is shown in blue and red candle chart format.

 

Regards,

Gregory H. Adams

Senior Portfolio Manager