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RIFLES VERSUS HAND GRENADES

After weeks of a slow grind higher setting multiple all-time highs, the stock market has arrived at a potentially important inflection point. As a result, I’ve decided to cover the current situation in greater detail than usual.

Although Alexander and I have the discretion to trade client accounts as we feel is appropriate for our clients age, and financial circumstances, we have as a goal of our firm to constantly stay in touch with you about what we are doing with your wealth and why. These weekly updates are designed to keep clients informed about the strategies, and tactics, being applied to your account(s), and to over time do some basic education about how the stock market really works. And, how that understanding is key to managing the risks associated with your participation in dynamic, and often chaotic global markets.

The law of supply and demand is the absolute bedrock upon which all of capitalism rests, and is derived in its various manifestations. Over the decades I have devised many strategic, and tactical, indicators to measure and monitor the ever changing balance of supply and demand in the equity market. The indicators we are using today have been constantly evolved over many iterations, and updates to things like control parameters to enhance the effectiveness of the original concepts now in the form of their resulting indicator formulations.

These surviving indicators incorporate modules to account for NYSE type data streams, and for selective data from the derivative markets, given that huge amounts of dollar risks are managed in the derivative markets these days. So the simple chart representations clients, and research customers, see in these weekly updates belie the sophisticated nature of the underlying, and constantly evolving products, and the math driving their formulations. Leonardo da Vinci once said: “Simple is the ultimate sophistication”. So, while the indicator representations shared with clients in our weekly updates look simple on purpose, the genesis behind them is quite sophisticated.

A good many of the supply and demand indicators, which are not shown from week to week, started life as tools for a futures trader I once tried to coach. Alas, the gentleman refused to incorporate the discipline required for successful futures trading into his approach to navigating day, and intermediate term trading, which in turn shortened his trading career, although he remained a successful tax attorney.  The survivors of those early tools, first developed in the late 1980s with personal computers with a fraction of the computing power available today, are still suitable for trading the S&P-500 eMini futures contract, although obviously that venue is not a focus of my work these days.

The fast moving venue of day trading futures, options and highly volatile stocks require indicators with “rifle” type accuracy, and the requisite laser mental focus to properly apply them. However, short term trading with highly leveraged instruments is still done most effectively with tools measuring the swift intraday changes in the balance of supply and demand. Given the dynamics of short term trading, one would likely expect the won/loss record to be adversely affected as the trading time frame shortens, even with indicators more on the “rifle” end of the accuracy scale, because random market “noise” tends to become more and more of a factor.

So where is the sweet spot for investors wanting to systematically, and methodically, increase their wealth? After decades of doing this research intensely, I prefer the intermediate time frames as the best balance of risk/reward for conservative investors needing to grow their wealth. Supply and demand indicators tracing their genesis to their development as futures trading tools tend to become more like hand grenades than rifles, as the trading time frame lengthens. But, as we shall likely soon see in real time, a strategic supply and demand indicator registering an accurate, but less than perfect, representation of the balance of supply and demand can be highly profitable, if combined and effectively applied with our proprietary tactical supply and demand indicators.

On the beaches of Normandy on D-Day the most effective weapon against the Nazis machine gun nests were grenades, not rifles. A grenade will do the job, even if you only get it in the general vicinity of the target, as opposed to exactly between the cross hairs. In like manner, as bottoms are forming according to our proprietary strategic indicators (hand grenade type market tools), a series of dollar cost averaging purchases will likely result in an averaged cost near enough to the price of the absolute low tick to effectively reduce the risks to a level, where an eventual profit becomes a significant probability. During this process, if our objective measurements determine that sellers have likely exhausted their propensity to sell, and our tactical indicators confirm a re-surgence in demand, then the already significant odds of success for our new purchases will likely be enhanced even more.

There are no guarantees of success in this business of managing risks, but objective measurements confirming the existence of exhausted sellers, followed in a reasonable length of time by measurements confirming a re-surgence in the demand for equities, tends to stack the odds of success heavily in favor of investors armed with these kinds of proprietary supply and demand tools. All that is left to do at that point is to have the courage to act on the potentially profitable information being displayed by the indicators. Having the courage to act, when opportunity arrives as it often does cloaked in fear, and/or whiffs of panic, has been the undoing many an extremely bright, and often highly educated, would be stock market operator!

So, never under-estimate the courage required to be successful in the arena of trading and investing. All the high intelligence, exclusive and expensive education, and elite training are meaningless, if one’s courage fails, or is lacking altogether. Coach Bobby Dodd, the late Georgia Tech football legend, was once playing a round of golf with his buddies, when his partner needed to sink a three foot putt to win the match. After leaving the putt an inch short, the partner turned and said: “Coach I hit it will every once of strength in my body”! When the pressure is on, one’s courage can fail, which can result in costly missed opportunities, if it happens while navigating the financial markets!

The current price weakness, which began in late January, continued this past week after an intervening bounce earlier in the week. The stock market finished near its low on Friday, and a number of objective measurements are now confirming that stocks are experiencing weakness on a level not seen since August 2019, and the fall of 2018. In the absence of objective information to the contrary, Alexander and I intend to treat the current correction as an opportunity to put excess cash to work.

I’ve included the weekly update from the week ending January 17, 2020 as additional information outlining how we intend to use this budding weakness to our client’s advantage. Please note this general outline was written as a loose template explaining how to identify price declines as opportunities, or on the contrary rising threats to invested wealth. At this point in time, this decline appears to be developing as an opportunity, but that is subject to change as measures of supply and demand change.

TATY   —   A REPRESENATIVE OF A FAMILY OF STRATEGIC SUPPLY AND DEMAND INDICATORS

TATY is shown above in yellow with the S&P-500 overlaid in red and blue candle chart format.

TATY finished the week at 137 marginally below the red zone surrounding the 140 level, as the often mentioned negative divergence (see down sloping orange line) finally won the weeks long struggle, and pulled the price lower with it. On a percentage basis, this is how divergences between the price and this strategic indicator, regardless of whether the divergence is negative or positive, are almost always resolved in favor of the indicator. Clients, and research customers, will likely see a positive divergence develop between TATY and the price, as this correction begins to end. TATY will likely bottom first, and begin to rally, before the price completes its decline creating a positive divergence between the indicator and the price. For a recent example, take a look at the month of December 2018 in the first chart above.

At this point in the development of the correction, a TATY reading marginally below the 140 level is not a reason for any serious concern. However, a TATY decline into the caution zone surrounding the 115 level would have to be treated as an early warning that the strategic (big picture) balance in the supply and demand equation may be beginning to change in favor of supply over demand. A follow on issuance of a “Big Chill” warning, would compel Alexander and I to consider, if defensive operations in portfolios were becoming necessary.

I’ve left the orange down sloping lines shown on the TATY chart to illustrate why it is important to pay attention to divergences, even though it may take weeks before a negative divergence grows strong enough to pull the price lower. The divergence shown on the TATY chart has been measuring the creeping loss of strength in the bidders driving the price higher, and recently the bid under the market has weakened enough to drag the price lower. Remember what TATY is measuring, while it looks just like a price chart, it is a record of the strength (or weakness), in the changing balance of supply and demand.

This is in like manner as your physician taking a number of medical measurements being created by your body, and then presenting them in chart form. The quantified medical readings are fundamentals impacting the health of your body, but the presentation is most often in the form of a technical looking chart. My work revolves around the most important fundamental in the stock market, the measurement, and constant monitoring of the balance of the supply and demand for equities. However, the presentation of this most fundamental of all market information often leads some clients, and would be clients, to mis-construe the work as technical due to its presentation format.

Now let us turn to the other negative divergence, the one shown by the other down sloping orange line in the lower panel of the TATY chart. The lower panel is a representation of the never ending journey of the price from premium to value, to discount to value, and back again. This round, and around circuit must be quantified in order for it to be applied in any useful way. I view the lower panel as the “LADIES” indicator, because our mothers, wives, and/or daughters are usually the most astute buyers in the family.

Peter Lynch, the former manager of the once famous Fidelity Magellan Fund, credited his success to following his wife around stores, and then buying the stocks of the companies, whose brands his wife was buying. The premium/discount indicator in the bottom panel of the TATY chart has nothing to do with brands, but everything to do with how our mothers, wives and/or daughters usually operate in a store. If she needs one of “My Favorite Brand”, and today she discovers it is on sale two for one, then guess what happens. Ditto for the ladies I see in the check out line with their hands full of coupons, must have those extra discounts you know. I like to buy stocks for clients the way my mother, wife and/or daughters have purchased for our needs over the years  —  at a discount to value.

Currently, we have TATY declining marginally below the red zone in the upper panel, and the premium/discount indicator in the lower panel finishing the week marginally below the red line at minus eight. Historically registering minus eight on the premium/discount indicator is evidence that a substantial enough discount to value is being offered by the stock market to do some buying in accounts with excess cash. Minus eight does not mean the discount is so large that the price decline will likely end immediately, nor that better prices are not yet to come. Until both TATY in the upper panel, and the premium/discount indicator in the lower panel, begin to paint out positive divergences to a still declining price the odds would still favor lower prices to come.

However, remember we are doing grenades here in an effort to dollar cost average into a really good price relative to recent history, as opposed to attempting to get the fleeting absolute price low between the cross hairs, which is virtually impossible. So, given that a persistent decline accelerated late Friday, I used the minus eight discount level to do some buying in accounts with excess cash, because recent corrections have been fleeting, and who knows what Monday may bring. The first couple rounds of dollar cost averaging into a long position is like an appetizer,  so save some hunger for the main course to come, and if the main course is a no-show, then we took what we were offered, and enjoyed the appetizer.

TATY has now painted out numbers consistent with those it generated during the fall 2018 correction, and the brief price weakness in August 2019. However, having dipped below the red zone surrounding the 140 level, and with the premium/discount indicator declining below minus eight, the potential exists for the development of positive divergences with a still declining price, then the appearance of objective evidence of exhausted sellers, followed by re-surging demand would likely compel us to consider putting all available excess cash to work in equities. Should TATY and SAMMY paint out a classic buy signal, then we will review the asset allocation of clients already reasonably invested to see if their exposure to equities needs to be adjusted in proportion to the strength of a new buy signal, and potentially renewed attempts to assault new all-time highs to follow. A new buy signal would likely take several days to complete, so this correction may linger for a while. If it does not linger long enough to complete the steps just described, then the implied failure to completely purge all the would be sellers from the mix could result in a potentially fragile and dangerous resumption of the previous record setting rally.

SAMMY   —   A REPRESENATIVE OF A FAMILY OF TACTICAL SUPPLY AND DEMAND INDICATORS

SAMMY is shown above alone, and below with the SPXL 3X leveraged S&P-500 ETF overlaid. The SPXL is for reference only.

SAMMY excels at identifying re-surging demand once sellers have exhausted their propensity to sell. Exhausted sellers are a necessary condition for the stock market forming a low risks bottom, but not a sufficient one. Stock market bottoms form when there is objective evidence of re-surging demand, after sellers have exhausted their desire to sell. During prolonged rallies SAMMY is virtually worthless. However, once the strategic indicator TATY bottoms, then begins to rally, and then establishes a positive divergence to a likely still declining price, SAMMY tends to become an extremely important indicator. SAMMY’s history is one of consistently alerting investors that buyers are returning to the market in size to scoop up perceived bargains. When this occurs SAMMY literally leaps higher, as if it were shot out of a cannon. This kind of indicator behavior tends to confirm that a low risks bottom has formed, or is likely to form in a matter of hours, or possibly days.

When SAMMY paints out evidence of re-surging demand, this is the signal for investors to complete their last round(s) of dollar cost averaging purchases of equities. Objective evidence of exhausted sellers followed shortly there after by evidence of re-surging demand usually results in the commencement of a new leg higher in the previous uptrend, or the establishment the first leg up in a new bull market, if the signal happens as a bear market is ending. A generally accepted definition of a bear market is a decline from top to bottom of twenty percent, or more.

Currently there is some evidence that sellers are on the road to exhausting their propensity to sell, but at this point it appears too soon for SAMMY to issue a buy signal given the lack of a positive TATY divergence with the still weakening price.

THE BOTTOM LINE

The most significant price decline vis-à-vis our indicators since August 2019, and the fall of 2018, is underway. We intend to use this weakness in the price to put excess cash to work, as our proprietary indicators uncover opportunities to dollar cost average into a potentially low risks position. Should a classic TATY/SAMMY buy signal be issued, all client accounts will be reviewed to see if they are candidates for an increase in equity exposure. Given the current stage of development of the correction, and the chart gymnastics required to be completed before a buy signal can be generated, a final round of dollar cost averaging may not be commenced for several more days.

I apologize for the length of this update. Given the infrequent low risks buying opportunities over the last several months, I want to use this current correction as a real time refresher course for clients of long standing, and as a teaching opportunity for new clients just beginning to learn about our approach to managing risks. Now that clients have two detailed templates about how this correction is likely to develop, complete, and then become a foundation for the next leg up of the previous rally, I intend to return to our more succinct format in the weeks to come.

 

DISCLAIMER : 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. 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.” 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 Optimist Capital LLC.

 

REFERENCES FROM ABOVE BELOW:

 

CLIENT AND RESEARCH CUSTOMER STOCK MARKET UPDATE FOR THE WEEK ENDING JANUARY 17, 2020

The stock market inched its way to new all-time highs this past week, as investors continue to exhibit an absolute conviction that good economic times are here to stay. Complacency, extreme bullish sentiment readings, and fear of missing out on the rally remain the order of the day. This situation reminds me of the old stock market cliché that says: “The stock market can remain irrational longer than you can remain liquid”. The status quo may continue, but in this business of managing financial risks to client wealth bullish extremes often appear toward the end of bull legs, and bearish extremes tend to appear near the end of bear legs.

Alexander and I are in the risk management business, and we do not attempt to forecast future movements of the price in the stock market. We will leave stock market predictions to those, which believe they have the requisite skill, talent and expertise, to be successful at that most difficult of arts. However, objectively measuring the ever changing balance of supply and demand in the equity market, and then setting those measurements into a historical reference is something we do routinely with proprietary indicators designed specifically to account for the ever changing balance of supply and demand created by countless transactions on the NYSE, and in the global derivative markets.

Human nature tends to repeat in the crucible of the stock market, and this makes comparison of objective measurements of human nature in action over time in the markets a worthwhile, and potentially profitable exercise. So today, very likely well in advance of a major stock market top, I’m going to briefly describe how the next major top will likely form vis-à-vis the tools we share with clients every week. I will bring you up to date on the current status of these supply and demand tools in the two sections to follow, and at the end of each section I’ll describe how these tools will likely configure their readings during a routine correction to re-invigorate demand, and/or how these tools will likely configure themselves as the next major top builds out. At this point, history suggests there will be at least one (or more) corrections prior to the formation of the next major top.

TATY   —   A REPRESENATIVE OF A FAMILY OF STRATEGIC SUPPLY AND DEMAND INDICATORS

TATY is shown above in yellow with the S&P-500 cash index overlaid in red and blue candle chart format. TATY finished the week up a bit at a strong 154. However, TATY continues to paint out a negative divergence with the price, which is touching new all-time highs. Negative divergences almost always result in the price entering a correction, but not always. Demand can gather strength during negative divergences, which can erase the divergence, but these events tend to be rare. Once buyers fatigue sets in, which appears as the negative divergence, that fatigue tends to go to completion in the form of a correction to set up lower prices, which in turn stimulates investors to act on their latent desire to buy at what appears, in the light of recent history, to be bargain prices.

In environments of bullish extremes like currently, corrections may appear to come out of the blue, and may be quite uncomfortable and nasty, but fleeting. History suggests investors may encounter just such a price decline during the first quarter, or as the positive seasonal bias begins to wane around Easter. As long as the next significant price decline results in a corresponding bottom in the TATY indicator in, or close to, the red zone surrounding the 140 level, then we shall treat such a decline as a potential opportunity to put excess cash to work. A price decline with a corresponding configuration in the TATY indicator would strongly suggest a continuation of the bull trend, and possibly renewed assaults on new all-time highs.

However, a price decline strong enough to drive TATY readings into the caution zone surrounding the 115 level would be a warning to Alexander and I that the dynamics of the supply and demand balance may be changing enough to compel us to consider, or even take defensive action in client portfolios to protect accumulated profits, and/or protect client wealth from risks rising to levels, which may not be prudent for conservative investors. The chart gymnastics required for the supply and demand indicators to complete the requisite patterns would likely take weeks, so in the near term we shall investigate declines as opportunities to put excess to work with lower risk entries.

SAMMY   —   A REPRESENATIVE OF A FAMILY OF TACTICAL SUPPLY AND DEMAND INDICATORS

SAMMY is shown above in the second chart alone, and in the third with the SPXL 3X S&P-500 ETF overlaid. The SPXL three times leveraged S&P-500 ETF is for reference only.

SAMMY has one purpose in life, which is to identify re-surging demand after sellers have exhausted their propensity to sell. Exhausted sellers are a necessary condition for a significant stock market bottom, but not a sufficient condition. To complete a bottoming process there has to be evidence of exhausted sellers, which is followed in a reasonable amount of time by evidence of re-surging demand. When both conditions are met, the probability of a new bull leg developing is extremely high. SAMMY is virtually worthless once it has signaled re-surging demand. So for now with a rally underway for weeks, SAMMY is shown for information only, and is of little value. However, as the next significant bottom forms, SAMMY will likely become critically important to us as a risk management tool for getting clients significantly more invested in stocks. At that next significant bottom I expect SAMMY to leap higher while painting out a bar on its chart completely above the previous bar. SAMMY looks like it has been shot out of a cannon when investors return in size, even as the price often is making new lows.

THE BOTTOM LINE

Timing the market is not part of anything we do at Optimist Capital, as we are strictly risk managers. However, in this update days, weeks, or possibly months before the next significant event in the stock market, we have described to our clients what we will do to manage the risks to your wealth, and how we will do it using objective market generated information from the NYSE, and the derivative markets. Opinions are subjective, and rife in this business, and tend to cause confusion, so all our actions are the result of taking into account what the markets are telling us about themselves through the objective information they generate. That information is then put into a strategic plan, which is implemented with the application of a tactical plan. This approach has been shown over time to allow us to grow wealth while minimizing risks. So now our clients know likely well in advance of us taking any actions what we will do, and how we will do it, in order to grow your wealth with the least risks possible.

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