Outlook

I wanted to give you, the good readership,  an outlook and strategy update given the frothy levels on the markets. This time of the year everyone does predictions. I won’t give a one year projection on where markets will be etc. Why bother? Those of us who follow charts are simply going to go with our rules. A sell signal will invoke a sell. Meanwhile, the market will deliver what it delivers.

However, I can pass on some thoughts regarding ValueTrend’s current positioning in these markets, and thoughts as to the state of their overall health.

Let me be specific—I’ll refer to the S&P 500:

 

Short term:

RSI and other momentum indicators (choose your favorites) are now overbought on daily, weekly and monthly charts. In 2011, 2014 and 2016, the same conditions carried on from mid-year into the end of the year (high RSI – as now).

During these periods there was a correction in December or January. Each time, the correction was finished within a month or so, and markets rose thereafter for a while. In 2016 the winter correction was all we got. Markets have been up without pause since then.

I “predict” the potential of a similar temporary correction to these years early in January or so. That’s why we have 20% cash in the ValueTrend Equity Platform. BTW–When markets correct in the winter they tend to revert back to bullish conditions quickly.
The chart below shows us that you often see a correction beginning in the very last part of December or into January-marked with vertical lines-its happened in most years since the bull began, except 2013.

Note the high RSI reading of late.

 

 

As far as near termed risk, we noted in one of the ValueTrend updates that we send to clients that we view the markets somewhat tepidly:

We have decided to approach this “buying” season cautiously. We are stepping in slowly and buying stocks – but not the overbought market leaders. We feel there is a strong potential for some rotation sooner or later from the frothy few stocks that have been solely responsible for this rampant market. We are going to hold at least 15% – 20%  cash even after buying stocks in the coming weeks. It is our view that a healthy correction is likely at some point in the near future. We’d like to have cash should that happen.”

Despite the very likely potential of a January correction that might be in the neighbourhood of 10% or so (as happened in 2016) – there are no mid termed indicators of a change in trend. Lets now cover the mid termed outlook:

 

Mid-term:

I prefer to look at the distance of the market (SPX) over the 200 day SMA (simple moving average) for my mid termed overbought/oversold evaluations. I’ve placed the 40 week (200 day) SMA as a red line on the chart above.   The market is above the 200 day SMA. I also pay attention to peaks and troughs on the weekly chart. It is making higher peaks and troughs.

Getting back to the SMA: The market is about 8% over the 200 day SMA. I consider it overbought if its 10% + over the 200 day SMA. Its approaching that level, so there could be a more traditional selloff later in the summer. But let me be clear—it is not officially overbought from a  mid-termed perspective yet—it’s still only 8% over the 200 day SMA.

 

Long term:

The only practical outlook that Elliott Wave Theory (EWT) can give is a rough picture of where we are in the market cycle. I have no doubt we are in Wave 5 of the cycle. I pay no attention to Fibonacci projections. Nor do I like tea leaves or astral cycles. But the character of Wave 5 is always the same—parabolic, low volatility, irrational exuberance, concentrated leadership. Past examples are the late 1990’s tech bubble and the 2005-2007 subprime, real estate and oil bubble.

Again, note the recent year’s activity on the chart above. The current evidence for Wave 5 since is: the low volatility, the parabolic look to the chart, and the concentrated focus on Fantastic Five superhero stocks (FB, AMZN, MSFT, AAPL, GOOGL). That, and bitcoin. The problem is that this final 5th wave may go for a while. Or not.  It will stop when it wants to.  Not when you or I want it to. So I follow a simple rule: Sell on a violation of the 200 day SMA and a lower trough on the weekly chart  – its even more significant if that break is followed by a rally that does NOT take out the prior high. In other words, all the conditions have been met that an uptrend is likely over. If the market does take out the last high, you go back in, having perhaps lost a bit of upside in the worst case scenario. In this way, you will protect your money from any significant bear market move while staying in the market during most of the uptrend. Read this blog for more info on how to sell properly.

I also recommend you read this blog for more info on Elliott Wave applications.

 

Neartermed strategy:

There is a tendency for this year’s underperformers to outperform in January – while outperformers often slow down or decline. At ValueTrend, we are holding stocks, sectors and markets that are somewhat underappreciated or have pulled back in a trend. Meanwhile, we are looking for opportunities in what we view is a very likely pullback in January. We are holding a bit less than 20% in cash with an eye on buying stocks on a pullback, should one occur. We have minimal exposure to the market leading overdone stocks—and greater exposure to what we feel are rotational candidates—below are the prime examples of sectors we own, or want to own, or want to own more of in a correction:

 

US Banks

Staples

Energy

Select overlooked stocks (e.g. we own Fairfax Financial, and that under loved dog, Cineplex).

I hope this helps in positioning your portfolio for the coming year.

 

11 Comments

  • Thanks again for this Keith. I remember impatiently holding cash from November 2007 and watching the TSX make new records through June of 2008. I will also note 2009 was my best year. I always appreciate your candid blog. Merry Christmas.

    Reply
    • Thanks Terry. Interesting you say that 2009 was your best year. In my 28 years in this business, I have NEVER had such a good year as 2009. That’s because I, like you, followed my system. My clients did much better than their neighbors by losing substantially (!) less during the crash – and recovered that smaller loss very quickly. We got huge numbers of referrals and new business from clients who were talking to their angry and depressed friends.
      Interestingly, here we are a decade later. I see the same signs of irrational exuberance as 2007 and 1999. How quickly people forget. Bitcoin anyone?
      This why I like to say that I look forward to volatility. For those of us who have a plan, its our best friend!
      Always stick to your system – it will save you from yourself!!

      Reply
  • Thanks Keith, your outlook is much appreciated!

    I have also been picking up some of the under performers, sold stronger stocks into strength (though I sold many too soon as they continue upward) and holding a lot of cash as well.

    Watching the USD with interest these days as it could have a significant impact on the “next” sector rotation. After the downtrend at the beginning of the year, it has been consolidating and is looking a bit weak. Is it possible it will break down further, that would be something given the monthly and weekly chart.

    Have a very happy and safe holiday.

    Reply
  • “MEDIUM TERM TECHNICAL INDICATORS FOR THE S&P 500 INDEX, THE NASDAQ COMPOSITE INDEX, THE DOW INDUSTRIAL AVERAGE AS WELL AS THE TSX COMPOSITE INDEX REMAIN OVERBOUGHT. PREFERED STRATEGY IS TO TAKE AT LEAST PARTIAL PROFITS ON SEASONALLY ATTRACTIVE EQUITIES AND E.T.F. DURING THE SANTA CLAUS RALLY PERIOD WITH THE UNDERSTANDING THAT THEIR NEXT SIGNIFICANT INTERMEDIATE UPSIDE MOVE LIKEKY WILL NOT RESURFACE UNTIL NEXT FEBRUARY”.

    (DON VIALOUX, TECH TALK, 11 DECEMBER 2017)

    KEY WORD IS MEDIUM TERM, ISN’T IT?

    Reply
  • Excellent article Keith – so helpful to know what to look for in a correction. Thank you for your pearls of wisdom.

    It seems markets are beginning to show signs of turn down after the Fed meeting yesterday. Gold looks to be near a bottom. Will you consider this sector with the possible impending correction and gold’s traditional role as a safe haven?

    Reply
    • Wanda I will blog on gold sooner or later. But at this point, the commodity is really quite stuck with a ceiling (resistance) at $1350-or so. Its been that way since 2013! Its trying to form a bit of a triangle within that long, long flat period–I don’t like the chart – and would only suggest that its a trade if you think you could catch it at a point where you could profit on a return to that ceiling of $1350-ish.
      Seasonality isn’t terribly great until the summer for it (there may be a bit of seasonal strength in the late December early January if I recall correctly–but its short lived)– so beyond a near-termed rally from its current oversold situation (daily chart) I’m not all that bullish on it.

      Reply
  • Hello again Keith,

    Thank You for sharing your insight on the technical view and using S&P 500.

    Would the outlook and strategy equally apply to the TSX?

    If not, are there simply variance to the view – or – would that be a whole other blog?

    J!

    Reply
    • Hi John
      I’ve talked about the TSX a few times in the past. While its true that you can certainly chart the TSX and extrapolate trends, support, resistance and patterns etc from it, I am less inclined to use it as an accurate index for overall trends within our markets. Thats because its a cap weighted index–in fact, its float adjusted, meaning that whatever is “popular” and held by lots of investors, its going to get a bigger weighting. Recall when Nortel was $124/share in August 2000. It was weighted 33% of the tSX 300 composite. Thats one stock controlling a third of the index movements!!! . Yes, the S&P 500 is too–but the cap weighting in it is (while not ideal) a bit more spread out between sectors–there has never (to my knowledge) been a stock that got a third of the index weighting. Even now, with the “flying five” (see my blog on this subject) being so high in capitalization – you still only have a 20% weighting between the 5 stocks on the S&P 500 index. The TSX has such a great reliance on energy, materials and financials. Something like 34% financial, 20% energy, and 11% materials. That’s 2/3rds of the index in those 3 sectors. To me, this paints an inaccurate picture of what the broader Canadian market looks like.

      Reply

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