Another insightful issue of the ChartWachers Newsletter has arrived!
December 15, 2018
Hello Fellow ChartWatchers!
Can you believe it? Our final newsletter of 2018. It's certainly been a busy year for us here at StockCharts, with tons going around the site, the launch of StockCharts TV, ChartCon 2018 – the list goes on and on. However, none of that is possible without your support, so on behalf of the entire StockCharts team, THANK YOU!
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Two of the earliest warning signs since October that the stock market was in trouble was the fact that economically-sensitive stock groups like small caps and transports were leading the market lower. And they're doing that again today. Chart 4 shows the Russell 2000 Small Cap Index undercutting its February intra-day low today to put it at a new 52-week low. Chart 5 shows the Dow Transports doing the same. Weakness in those two groups is a negative warning sign for the market and the U.S. economy. So is the drop in our last chart. Chart 6 shows the S&P Retail SPDR (XRT) also falling to a new 52-week low. And that's happening during the Christmas shopping season which is supposed to be the best time of the year for retailers. It seems clear from the heavy selling in those three groups, and the rest of the market, that investors are bracing for bad economic news in the new year. And they're not waiting around to hear that news. That's why stocks usually peak before the economy. And why we can't use old economic data to predict the direction of the economy or the stock market.
As obvious as it seems, lower lows and lower highs are the order of the day in a downtrend. Thus, prices are expected to break prior lows and continue lower when the trend is down. Taking this downtrend concept one step further, one could also assume that support levels within downtrends are highly questionable and offer false hope. After all, lower lows are the norm, not the exception.
Our first job as chartists is to identify the bigger trend at work. Once trend direction is established, we can then direct our focus and set our trading bias. I try to focus on resistance, bearish setups, and bearish patterns during a downtrend. By extension, I try to ignore dubious support levels, bullish setups, and bullish patterns. I am working under the assumption that the bigger downtrend is the dominant force at work. A downtrend environment favors bearish resolutions over bullish resolutions. Bearish patterns have a better chance at success than bullish patterns, while resistance levels have a better chance of holding than support levels. It is all about probabilities.
Invariably, there is always another support level below current prices and we could draw dubious support lines all day. Marking support levels in a downtrend is just creating more noise. The chart below shows the S&P 500 with at least nine possible support levels. As far as I am concerned, the trend reversed with the price breakdowns and bearish breadth signals in mid-October. Once the trend turned down, support levels based on prior lows became noise in my book.
There is probably one "critical" support level in this bunch, but good luck picking the right one. The S&P 500 is clearly not "On Trend" and I will not be marking support levels until the index actually reverses its downtrend. In Dow Theory terms, the onus is on the bulls to prove the bears otherwise. Until then, I will respect the downtrend and be a good Grinch. Merry Christmas and Happy New Year!
The Financials Sentiment Indicators Suggest This Might Need More Time
by Greg Schnell
It looks like another tough month for the markets as year-end approaches. The index swings are getting increasingly aggressive and it feels like nearly every sector is getting yanked around. While there are lots of reasons to be bullish based on some of the "oversold" sentiment indicators, other reasons suggest a more worrisome stance.
In the chart below, the top panel shows the KBE Bank ETF, which has sold off by 25%. The dip isn't quite as big (in percentage terms) as the big dips of 2011 (42%) and 2016 (28%) were.
Looking at the Financials Bullish Percent Index in the center panel, we can see that we are down near some of the big retracement levels. 2008 and 2016 reached these low levels close to the start of the new year.
The percentage of stocks above the 200-day moving average is shown in black on the bottom panel. When the market gets this weak, it typically needs more time to correct.
Currently, one of the big problems is that the global banking charts look terrible. As one of the New York-based technicians said, when the banking charts go bearish, that is when there are problems. The reason is that the bankers can see everyone else's books. The chart below shows the European Financials ETF. Even though there is no divergence on the chart yet, the ETF is off 30% from its highs.
The US Bank charts have plummeted in the last 9 trading days. The KBE Bank ETF has sold off 13% in two weeks and is 24% off the high. Ouch!
While the Fed has been raising rates, these US banks were coping in the first half of the year. However, this has clearly changed after the June highs, which was when the banks diverged from the $SPX. The Fed meeting on Wednesday, however, could cause a change in sentiment. The next 10 days will need a rally to turn the $SPX positive for the year.
This Final Bar video shows some concerning charts. However, getting ready for the next rally is key.
I have been discussing the gold setup for weeks now, but the breakout seems to just be getting started. In the video, I work through gold and would encourage you to view this setup in detail. With the US Dollar pushing higher again this week, the gold-related trade has slowed.
For those of you who are looking for a small gift, you might have family or friends that would like to learn more about the basics of charting; if so, they'll love Stock Charts for Dummies. The first section of the book walks through all the chart settings to get the charts you want, the second section explores why you might use charts for investing and the third section is about putting it all together.
Want To Know The Difference Between A Correction And A Bear Market?
by Tom Bowley
Not a whole lot.
I guess there are three primary differences. First, there's the percentage drop as corrections are generally considered to see a drop of less than 20%, while bear markets tend to see declines well in excess of 20%. Second, a bear market tends to last longer than a correction as the latter is nothing more than a basing period (that can still be extremely emotional) during a bull market. Corrections are actually quite constructive for a longer-term rally. Finally, there's a much stronger likelihood of an economic recession during a bear market. Corrections are mostly accompanied by a slowdown in economic growth, but GDP typically remains positive.
My topic for this article was prompted by an email that I received from a subscriber to my daily Trading Places blog articles. Here's a quote from that email:
"Tom, you've said for months that this is just a market correction. At what point would you say this is the start of a bear market? Please help me understand the difference."
Let me start by providing a little stock market history. If we use 20% as the minimum downside threshold to have a bear market, then we've had 10 such bear markets since I was born in 1961. (Please do not do the math. And if you do the math, please don't remind me of the answer). Below are the total number of days spent in bull markets vs. bear markets in my lifetime:
Days spent in a bull market: 17,384
Days spent in a bear market: 3,548
We have been in bull markets five times longer than we've been in bear markets since 1961. So my first conclusion from this is that I don't want to err on the side of bearishness unless it's warranted. Most declines and most corrections are not bear markets. Have you ever heard the saying that someone has successfully predicted "19 of the last 2 bear markets?" Most investors/traders, by their very nature tend to be pessimistic. And for very good reason as most people do not enjoy losing money. Losing money makes us very emotional and extreme emotion, ironically, is one of the greatest predictors of market bottoms.
Ok, it's time for a chart. Let's take a look at the correction from 2014 through 2016:
After each of the selloffs that generated high VIX readings, most notably in October 2014, August 2015, and January/February 2016, the VIX settled back down beneath a critical 16/17 support level. Why is that level critical? Well, for starters, bear markets require a certain level of fear to trigger selling episodes when bad news hits. Also, if you look back at the last two bear markets, the VIX never closed beneath 16. Not once. The emotional component would rise to a level to support a bear market, but it didn't stay there - a clue that we were looking at a correction vs. a bear market. The final clue was obvious. Price support from the initial move lower in 2014 was never broken as it held on future emotional market meltdowns. The S&P 500 ultimately broke out to new highs in July 2016 and the bear market discussion ended.
Let's compare that to the current action:
One of the biggest differences now vs. earlier in 2018 is the fact that market rallies have been stymied when the VIX has fallen to 16. That support is holding similar to the past two bear markets. In my opinion, however, the bear market doesn't confirm until we see a price breakdown. Here's the chart of the latest bear market that began in October 2007:
The breakdown in early 2008 began the series of lower highs and lower lows that are experienced during a bear market. Until that breakdown occurs, the prior series of higher highs and higher lows remain intact. That's why, for me, I need to see the confirmation or the bridge, if you will, from a correction to a bear market.
A correction and a bear market start from the exact same level - the bull market high - and in the same exact manner. There's no need for anyone to differentiate between the two because they both begin the same way with increasing volatility and panicked selloffs. It's what happens after the intial selloffs that determines what we're dealing with.
There are other signals that should be addressed, however. For instance, when the S&P 500 established its initial key price support in February 2018, so too did the Russell 2000 ($RUT), Dow Jones Transportation Average ($TRAN), Dow Jones U.S. Banks Index ($DJUSBK), among others. All three of these key indices have broken to new lows. Crude oil ($WTIC), a signal of global economic strength/weakness, has cratered, falling from $77 per barrel to $50 per barrel. Money has been rotating towards defensive areas of the market, with the latest warning sign there being the drop in 10 year treasury yields ($TNX) back beneath 3.00%. The TNX falls when treasury prices rise. Once we saw the drop in the TNX below 3.00%, relative strength in economically-sensitive areas like financials and transportation stocks crumbled. All of this "under the surface" action is quite different than it was in February 2018, which is why I've become much more concerned about this evolving into a bear market.
Could we still rally from here? Could this still be just a correction? Yes, I believe it could. But whereas I'd have given a 1% probability of a bear market in February 2018, I believe that probability is more like 90% now. The last missing piece is the S&P 500 breakdown below critical price support. In my view, that changes the game because it establishes the "lower high, lower low" mentality that drives bear markets.
I'm joining John Hopkins, President of EarningsBeats.com, for a 2019 Stock Market Outlook on Wednesday, December 19th at 4:30pm EST. There could be much more clarity with three more trading days next week under our belt and I'll be discussing the above along with a host of other topics as we brace for a brand new year!
Listen, I'm prepared for a bear market and I'm also prepared for a continuation of the decade-long bull market. I have both a Strong Earnings ChartList featuring companies that have recently beaten Wall Street consensus estimates and a Weak Earnings ChartList featuring companies that have missed the boat and disappointed Wall Street. I'll be discussing both and how to use them effectively at this upcoming webinar. The webinar is FREE, but you must register for the event. For more information, CLICK HERE. It'll be an in-depth look at what we can expect in 2019 so please plan to join me and John if you can!
Consider This New Year's Stock Market Resolution And Change Your Financial Future
by John Hopkins
First, I'd like to wish everyone a Merry Christmas and a Happy New Year!
2018 has been a wild ride with volatility returning to extreme levels. Unfortunately, 2019 looks like it will get even worse. I believe we're in a bear market and, at EarningsBeats.com, we've already made preparations for it. A bear market doesn't have to mean losses in your portfolio. You have options. Sitting in cash increases your buying power when an ultimate bottom forms. Trust me, being in cash while the stock market falls is the second best thing to making money! We will not be satisfied with simply holding cash, however. A bear market presents opportunities too. It just requires a different mindset. Rallies should be shorted. If you only trade on the long side, there will be opportunities there as well, but you'll need to be extremely quick with your trigger finger as rallies, once they're complete, will turn and likely turn very quickly. It also makes sense to trade more defensive stocks on rallies as those stocks tend to hold up much better in a bear market.
Whether you're bullish or bearish heading into 2019, we have the best stocks to consider trading. While trading on the long side or short side can make you money, there's one common denominator with both. In fact, the best and most successful traders exercise this one common trait, no matter the trade.
They manage risk extremely well.
What does that mean? Well, it can mean a lot of different things to a lot of different people. For us at EarningsBeats.com, it means mapping out a trading strategy (entry point, exit point, target) before ever entering the trade.
Let me give you two examples, our last two alerts to members. One is a clear winner, the other an obvious loser. But downside risk is contained in both and that is critical.
The first example is Wright Medical Group (WMGI). The company beat Wall Street estimates as to both revenues ($194 mil vs $186 mil) and EPS (($.09) vs. (.15)). WMGI gapped higher when the opening bell rang. After trading as high as 30.75 on November 8th, it fell back to a major price support level, one that had been tested on at least three prior occasions. There was no guarantee that price support would hold, but that level presented the best reward to risk entry point. It's how we manage risk and produce the risk-adjusted returns that we do. Here's the chart:
We alerted our members to WMGI at 26.49. Our original target was 29.00. You can see a few previous tops just above that 29.00 level. Our stop was (1) a close beneath 26.25 (violating gap support), or (2) an intraday move below 26.00 (violation of all prior intraday lows since August), whichever triggered first. That set up a potential reward of 2.51 to our target or .51 to our intraday stop. That's a 5:1 reward to risk ratio (R2R). If you trade with discipline and patience, these types of trades will present themselves on a regular basis. We ended up removing WMGI at 28.20 on December 7th, with a profit of 6.46%. We removed it early for two primary reasons. First, the overall market was beginning to look more and more bearish so using a market rally to take profits simply made sense. The second reason was.....well look at the red-dotted line on the chart above. 28.20 was testing a downtrend line. We didn't want to risk our 6+% profit that was earned in just 5 days. This trade really encapsulates what we're about. A really good call was made, WMGI rebounded as expected from a desirable price support level and we booked profits. Our trifecta! Since our sell, WMGI has pulled back and a portion of our gain would have been given back had we continued to hold. WMGI remains a solid stock, but there's a reasonable chance it'll retest that price support level again. Why turn your nose up at a 6.46% profit in 5 calendar days? We didn't.
Every trade doesn't work that well and I'm not trying to tell you that they all will. In fact, my second example went against us, so let's look at Nomad Foods Ltd (NOMD). Like WMGI, NOMD produced excellent quarterly results in early November and resulted in a nice gap higher. Both revenues ($617 mil vs $584 mil) and EPS ($.30 vs $.26) easily exceeded expectations and the stock was added to our Strong Earnings ChartList. Then we exercised patience until NOMD moved to a price near major price support. Either we'd see a rebound and capture profits like we did with WMGI....or we'd get stopped out quickly. Here's the chart:
Our buy alert to members was sent on December 11th at 18.55. Our target was set at 20.10, slightly beneath a key price resistance level. Because of volatile market conditions, we decided to establish an INTRADAY stop just below that day's low of 18.42 so we set our stop at 18.40. Friday (December 14th), NOMD opened at 18.40 and we were quickly stopped out at 18.39, representing a 0.86% loss.
Two trades, one winner, one loser. But a significant net profit. Honestly, these last two trades could be the poster child for EarningsBeats.com. It's all about taking your profits before they're lost and managing downside risk.
Getting back to my article headline, please make this New Year's resolution. Manage your risk better. If 2019 turns out to be a bear market, which I believe it will, managing risk will become an even greater priority.
I started this EarningsBeats.com service in October 2013 along with my former partner and current Sr. Technical Analyst at StockCharts.com, Tom Bowley. We produced a service that works and has been time-tested. In a bull market, trading stocks that beat Wall Street estimates has proven to be very profitable. Moving forward, we're going to be looking at shorting stocks that have missed Wall Street estimates. Accordingly, we now have two watch lists as follows:
Strong Earnings ChartList: 227 stocks on list
Weak Earnings ChartList: 67 stocks on list
On Wednesday, December 19th, Tom Bowley will be joining me to conduct a "2019 Stock Market Outlook" webinar just after the market closes. It's a FREE event, but you must register in order to attend. For more information, CLICK HERE. Those attending will have an opportunity to gain access to BOTH of the ChartLists mentioned above. It'll be your first step to more effectively managing your risk in 2019 - I hope to see you there!
This webinar will be at capacity guaranteed! So register now and plan to arrive EARLY (immediately after market closes on Wednesday) to make sure you get a LIVE seat. If you have any questions, please feel free to email me at email@example.com.
Portfolio Management and Asset Allocation: Supercharge These Using Powerful Morningstar Tools
by Gatis Roze
The most important thing in my life is not money — it is my time and my health. These two items are far more important to me than monetary assets. As a result, I’m always focused on how I spend my time and less on how I spend my money. If this strikes you as reasonable, then you’ll be pleased as an investor with the tools I’m about to share with you. They are tools that will enhance your financial health while also minimizing the time necessary to make that prosperity a reality.
A few caveats upfront. For over 25 years, I’ve been a full-time investor. I’ve taught investment courses for 18 of those years. All too often, I’ve encountered investors who disregard asset allocation. They think it doesn’t matter until it does. Then suddenly, they become bi-polar beasts making stupid choices.
Markets change. Markets shed outdated favorites and formulate new dance partners. Yes, it’s Darwinian. It’s not the smartest or the strongest investors who survive. It’s those who have the requisite tools to adapt and to change when new circumstances warrant it. These are the investors with appropriate portfolio management skills and good asset allocation hygiene necessary to boost their performance versus detonating their assets.
In using Morningstar for over two decades, I’ve discovered many tricks, templates and tools that will help you also to supercharge your portfolio. Just one example: the “X-Ray” function is the best portfolio tool in the universe and it alone is worth the subscription. Whether your passion is stocks, ETFs, mutual funds or bonds, this video will expose you to a sensational array of tools and comparative techniques guaranteed to make you a better investor. Enjoy!
Trade well; trade with discipline!
- Gatis Roze, MBA, CMT
PMO Analysis - Wrong Direction and Not Oversold Enough
by Erin Swenlin
The Price Momentum Oscillator (PMO) is a great measure of acceleration/deceleration of price for individual entities. Combining each component's PMO readings within an index is especially advantageous in allowing us to understand how overbought or oversold it is in three timeframes. Although readings are oversold, they are still declining. This suggests that prices within the SPX, OEX and NDX are vulnerable to more downside price action.
Let's review each of the panes below price. The first is the short-term indicator, which measures whether a PMO is rising. For reference, you can look at the index's PMO to visualize. Below it, the intermediate-term indicator measures how many index components are on PMO BUY signals, meaning the PMO is above its signal line. Finally, the long-term indicator measures whether the PMO reading is above or below the zero line.
On the SPX PMO Analysis chart, note that while the short-term indicator is quite oversold already, it can still move further into oversold territory. The same goes for the long-term component. The IT indicator window is oversold as well, but it can certainly continue lower into more oversold extremes. Ultimately, the problem is that all three are declining. We need to see a bottom on at least some of the indicators in order to fuel a rally.
The NDX shows nearly the same picture, except that I noted a steep downside acceleration in the thumbnail for the % PMO Crossover BUY Signals. Indicators are oversold, but not at extremes.
The last PMO Analysis chart is for the OEX. Like the NDX, we are seeing acceleration to the downside on % PMO Crossover BUY Signals.Conclusion: PMO analysis shows that while readings are oversold, they can certainly get further oversold. We can see this in action right now as current readings are continuing to decline. Typically, we don't see a rally until at least one of these indicators bottoms. If you'd like to have a copy of your own PMO Analysis charts, download the "DecisionPoint Market Indicators" ChartPack. It's free to Extra members and above! Just go to "Your Account" in the upper right-hand corner and click on "Manage ChartPacks."
Technical Analysis is a windsock, not a crystal ball.
The "Yield Curve" is a term often used in finance and refers to the relationship between (government) bonds with various maturities.
The "Normal" relationship between the yield on various maturities is that the longer you lend money to someone. In this case the US government, the more "yield" you require. Similar to your mortgage, a fixed rate for five years is cheaper than a fixed rate for ten years or longer.
There are a few ways to look at yield curve relationships.
10-yr Minus 2-yr Yield
A popular, and generally accepted, way to look at the yield curve is shown in the lower pane on the chart above.
This plot shows the difference between the yield on 10-year and 2-year maturities. In a "Normal" situation that relationship is above 0%. When that relationship drops below 0%, the yield curve is "Inverse".
You can create similar charts for the different segments on the curve, for example, the difference between 5-year and 2-year yield or 10-year and 5-year yield.
The shaded ovals indicate where the curve inverted in the past.
It's not only the difference between the two yields that gives you information but also the direction in which that difference is moving. When the difference is rising it means that the curve is "steepening", when the difference declines, the curve is "flattening". This changing of the shape is indifferent from the level of the difference.
All these observations on and inside the yield curve can help investors paint a picture on, primarily, the macroeconomic aspects of changes in yield
The Complete Curve
You can get a more granular view on the yield curve and the possibility to see the interaction between various segments by using the Dynamic Yield Curve tool.
The chart above shows the various points, maturities, on the curve from 3-Months all the way up to 30-years and their yields. The nice thing about the Dynamic YC tool is that we are able to take a "snapshot" of the curve on a specific date and then move the slider in the (S&P) chart on the right to a different date and then see how the shape of the curve has changed.
The darker red curve is the situation at the beginning of 2010, the bright red curve is the current situation. As you can see the yield on longer maturities came down while the shorter maturities moved higher, changing a very steep curve in 2010 to a very flat curve now. The segment between 5-year and 2-year is exactly flat at the moment while it was slightly inverted, below zero, a week ago.
The Yield Curve And The Business Cycle
If we go back to the chart at the top of this article, you can see that I have overlaid red and green dashed vertical lines. These lines mark the peaks (red) and troughs (green) of the business cycle as defined by NBER (National Bureau of Economic Research).
So from a red to a green line marks a contraction period and from green to red marks an expansion period.
The information on the direction of rates and the changes in the shape of the curve is often used to determine where we are in the business cycle.
Combining the information that you can extract from the yield curve with the known behavior of the yield curve in relation to the various stages of the business cycle can help to determine where we are in the cycle which will then help you decide between risk on/off and/or over-/under-weighting equity sectors.
Adding all this up leads, IMHO, to the quick conclusion that we are now very late in the expansion phase or maybe already even in the early recession phase.
Use Relative Rotation Graphs to pick up steepening or flattening trends of the curve
Finally, I cannot omit them, RRGs can help you to pick up shifts on the yield curve from flattening to steepening and vice versa by plotting bond ETFs tracking various maturities on a Relative Rotation Graph as shown in the chart above.
This blog article explains more in depth how you can combine RRGs and the Dynamic Yield Curve tool to make better-informed decisions.
My regular blog is the RRG blog If you would like to receive a notification when a new article is published there, simply "Subscribe" with your email address using the form below.
Julius de Kempenaer | RRG Research
RRG, Relative Rotation Graphs, JdK RS-Ratio, and JdK RS-Momentum are registered TradeMarks ®; of RRG Research
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