Conviction Drives Pricing
When the conviction to own stocks is higher than the conviction to sell stocks,
markets tend to rise. Therefore, we can learn something in any market by focusing
on the fact that all trades have a buyer and a seller.
A Bullish Triangle For The Bulls
The S&P 500 recently broke above previous resistance (see green arrow
in chart below). The series of higher lows prior to the breakout told us buying
conviction increased at higher and higher levels within the period of consolidation,
which leans bullish. Has the concept of higher lows been helpful? Yes, a May
1 video clip covered the "higher
lows allow for some patience" strategy in detail.
The study of charts is not a form of voodoo or witchcraft, but rather a way
to monitor the actions of human beings within the context of simple and easy
to understand economic principles. The formal name of the S&P 500's recent
pattern is an ascending triangle. From stockcharts.com:
An ascending triangle has a definitive bullish bias before the actual
breakout...the horizontal line represents overhead supply that prevents
the security from moving past a certain level. It is as if a large sell
order has been placed at this level and it is taking a number of weeks
or months to execute, thus preventing the price from rising further. Even
though the price cannot rise past this level, the reaction lows continue
to rise. It is these higher lows that indicate increased buying pressure
and give the ascending triangle its bullish bias.
Consumers Drive The Economy
If we felt like we were about to lose our job or felt like it may be difficult
to pay our mortgage, we probably would not be planning a discretionary family
trip. The projections for travel this year also align with the market's recent
push to new highs. From Bloomberg:
About 37.2 million Americans will travel 50 miles or more from home during
the upcoming holiday weekend, the most in 10 years, according to AAA, based
in Heathrow, Florida. This 4.7 percent projected increase from 2014 includes
trips by car, air, cruise, train and bus in the May 21-25 period. Memorial
Day provides "a good indication of what's ahead" because the holiday marks
the unofficial start of the peak vacation season, said Julie Hall, a spokeswoman
for the largest U.S. motoring association. This "very positive forecast" should
continue throughout the rest of the summer, she said.
More Than Just Shampoo
As we covered in detail in Is
The Smart Money Running For Cover?, the ratio of growth-oriented
small caps vs. defensive-oriented Treasuries had a "risk-off" look during
the 2008 financial crisis. The chart below aligns with economic common
sense and was helpful in terms of reducing risk between the October 2007
high and March 2009 low in stocks.
The 2015 version of the same IWM:TLT ratio has been trying to form a constrictive
base since September 2014 (see below). Bottoms can form after sellers have
been "shaken out" in a pattern of fear, followed by a larger spike in fear,
and then one last, but more shallow, bout of fear.
The formal name of the pattern above is an inverse head-and-shoulders. From stockcharts.com
As a major reversal pattern, the Head and Shoulders Bottom forms after
a downtrend, and its completion marks a change in trend. The pattern contains
three successive troughs with the middle trough (head) being the deepest
and the two outside troughs (shoulders) being shallower.
Confidence Returning To Credit Markets?
In the ETF world, if you are experiencing maximum economic fear (think 2008),
then you believe three things:
- The economy is nowhere close to recovering,
- Stocks will be losers for some time, and
- The Fed is not even remotely close to raising interest rates.
Under maximum fear conditions, return of principal is more important than
yield and longer maturities are more attractive to "lock in your coupon rate",
which means there tends to be great demand for Treasuries (TLT) backed by the
full faith and credit of the United States government. If return of principal
is more important than yield, then high-yield bonds (JNK) with higher default
rates are much less attractive than TLT. The JNK:TLT ratio also has a head-and-shoulders
bottom look in 2015.
Yes, we understand there is a maturity mismatch between JNK and TLT in the
chart above; maximum confidence means the economy is stronger and rates may
go up - therefore, you want to diversify maturities by adding some shorter-term
bonds to the mix. We are looking at max confidence vs. max fear.
Stocks Outpacing Bonds
The ratio of stocks (SPY) to bonds (TLT) also supports the recent breakout
by the S&P 500.
How did the same SPY:TLT ratio look in 2008? Answer - quite a bit more fearful
(see below).
How About A Cup Of Coffee?
The 2015 weekly chart of financial stocks (XLF) has a potentially bullish
formation known as a "cup with handle".
Like some of the previous charts, markets often need to shake out investors
with doubts to bring investors with greater bullish conviction into the mix,
which is what is happening in the cup and in the handle above. From Investopedia:
"A pattern on bar charts resembling a cup with a handle...As the stock
comes up to test the old highs, the stock will incur selling pressure by
the people who bought at or near the old high. This selling pressure will
make the stock price trade sideways with a tendency towards a downtrend...
then it takes off. "
Housing Provides Some Economic Hope
Charts have people and economic data behind them. The most recent read on
housing aligns with the bullish economic case and charts above. From CNBC:
U.S. housing starts jumped to their highest level in nearly 7-1/2 years
in April and permits soared, offering a glimmer of hope for an economy
that is struggling to regain strong momentum after a dismal first quarter.
Groundbreaking surged 20.2 per cent to a seasonally adjusted annual pace
of 1.14 million units, the highest since November 2007, the Commerce Department
said on Tuesday. The per cent increase was the biggest since February 1991.
What Could Spoil The Bullish Party?
If you want something to be concerned about, look no further than the Fed
and interest rates. If market rates rise too quickly, it could spook both the
stock and bond markets similar to 1994.
Investment Implications - The Weight Of The Evidence
The charts above are part of the weight of the evidence tracked by the CCM Market
Model. Nothing really new to report - the hard evidence is still calling
for an equity-heavy portfolio via a mixture of U.S. and foreign stocks. If
the evidence shifts, we are happy to make the necessary adjustments, but
we need to see it rather than anticipate it. If you want to expand on these
concepts, this week's stock market video compares
2015 to a pre-correction period for stocks in 2011.
