by Andrew Adams CFA, CMT, Saut Strategy LLC
Charts of the Week
Regular readers likely know that my reports are typically focused more on the shorter term action of the market. Hopefully this goes without saying, but it’s not that I don’t believe the long term isn’t of the utmost importance; it’s just that the long term mostly stays the same from week-to-week which doesn’t exactly lend itself well to a weekly market commentary. If I didn’t write about the short term stuff, these reports would be rather brief, boring, and repetitive (“It’s still a bull market…buy stocks…see you next week!”). What’s more, the short term noise does eventually add up to create long term trends so by following along day-to-day and week-to-week it is hard for the market to get too far away from expectations, which helps in preventing big losses. A short-term focus also makes it easier to spot potential red flags and inflection points before bigger moves take place, an added bonus.
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Meanwhile, from a personal portfolio perspective, the reason I lean more toward short term trading is also pretty easy to explain: I just don’t think I am a very good long term investor. That’s a tough thing to admit for someone who loves the stock market as much as I do, but it’s the truth.
There is little point in me trying to research and uncover that magical stock that’s going to go up 500% over the next three years because I will not hold it that long. I admire those who have the conviction to hold for the long term without getting shaken out of positions, but it’s not one of my strengths. We all like to look back and say “Oh if I had just held Amazon for the last twenty years I’d be up 1500%,” but rarely considered is the fact that the stock went sideways for an entire decade before breaking out in late 2009 and that there have been separate drawdowns of 95%, 57%, 65%, 33%, 31%, 32%, and 37% in order to capture the entire performance since 1999. I’d rather not deal with that kind of sickening volatility no matter the upside, and so instead my bread-and-butter setups have become those more common situations where a stock can move 5- 20% in a matter of days.
Yet, I had to dust off and don my investor hat this week during a conversation with one of my close friends. Like many 30-somethings, he knows very little about investing and has missed out on much of this bull market thanks to the Financial Crisis period setting his expectations for the stock market.
But now that he has kids he knows he needs to plan more for the future and so asked me (in theory of course) for some areas into which I would periodically invest money that isn’t expected to be needed for at least the next 10-20 years if growth potential was the main objective (actually he asked me for some stocks that he could hold for 10-20 years but there weren’t any I was comfortable recommending). After first trying to squirm my way out of answering since I figured no good could come of it, I finally relented and gave him some broad themes on which I would focus and pair with some sort of general market fund (note: funds listed are just popular/liquid ways to play the theme, not necessarily the best):
- Biotechnology/Medical Devices (e.g. IBB, IHI) — Insurance and pricing are still a mess but there’s too much technological upside potential for that to discourage a long-term investment.
- Cyber Security (e.g. HACK) — In a future where everything is “smart” this should only become even more of a factor.
- Artificial Intelligence/Robotics (e.g. BOTZ) — Still in the very early days of what will eventually be possible.
- Emerging Markets (e.g. EEM) — The last ten years haven’t exactly been great for the developing world in terms of stock performance. That doesn’t mean the next 10-20 years won’t be, especially with the demographics at work.
- Alternative Energy (e.g. ICLN) — Investment dollars should continue to pour into cleaner energy options as the world shifts this way.
- Aerospace/Defense (e.g. IAT) — Governments aren’t likely to stop spending big on defense. Lot of technological innovation at play here too.
Obviously there will be times when these areas are out of favor and others are in favor, but for someone who just wants to let their investments ride for the long run these are themes in which I’d be very surprised if stocks tracking them weren’t much, much higher a couple decades from now. Moreover, if someone was interested in holding individual stocks for many years these would also be the areas in which I'd start my search. I reminded my friend, as well, that for someone who truly has a long time horizon and is dollar cost averaging, a declining market can actually be a very good thing so not to worry too much if we do go through a rough patch. Now if I could only learn to practice what I preach!
Switching back to the near term, I’m really beginning to hate Fed weeks. The last two sessions have been a snoozefest, even with crude oil shooting up 10% over the weekend. The S&P 500 has mostly been stuck within a 10-point range between 2992-3002 as investors and traders await this afternoon’s policy decision announcement from the Federal Reserve. Curiously, the odds of a further rate cut today have gone WAY down according to the CME FedWatch tool. Just last week the odds were above 90%, but, given that the y/y Consumer Price Index (CPI) for August came in at an 11-year high, those odds have now crashed to around 50%, making it a toss-up. For once then, the market seems unsure of what to expect and the lack of price movement is reflecting that.
On balance, the broad market is still looking pretty good. It did get a little overheated after the S&P 500 rallied about 100 points in seven sessions to break from its August trading range, but there hasn’t been any real selling pressure resulting from that extended position. That can, of course, change depending on this afternoon’s outcome but for now there isn’t anything that overly concerns me and it looks more like a pause than a top.
The Semiconductor Index (as always) is worth watching closely near its all-time high and the top of its weekly Bollinger Band (see page 11), but breadth looks good and the market handled the oil shock relatively well, with most oil stocks jumping on the development. Higher oil prices are often thought to be a bad thing for the economy since it increases costs on consumers and companies that use oil as an input, but $60 oil isn’t a problem and at least over the last few years higher oil prices have actually coincided more with a rising stock market than a falling one (see page 14). The Saudi Arabia situation may just be temporary, but oil prices will likely remain in focus in the near term regardless.
So, for now we await what the Fed does today. Just like last week, as long as the indices stay above their recent breakout points it’s hard to recommend getting too defensive even if major resistance does lurk just above the S&P 500 (see page 7). That resistance could be broken or the index can “ride” it higher without giving back too much, as it has done previously in recent years (see page 8). A breakout above it is probably needed to kickstart any real powerful move higher, and would likely mark the beginning of the next major leg of the bull market. Conversely, failure and a breakdown here puts us back in the same situation as the beginning of August and would not be a good look for the long term chart.
S&P 500 Sector Snapshot
S&P 500 Hanging in There
Since breaking out from its August trading range, the S&P 500 has managed to stay above it while also once again challenging its late July all-time high. That zone around 3020-3030 has offered some resistance, but there has been little selling pressure and the index remains above its key moving averages. No real red flags here, then.
S&P 500 Nearing Major Resistance Again
In addition to the resistance near the all-time high, just above there sits that major resistance line I have called attention to over the last few months (red line). This line has capped the index so far and may continue to be a tough obstacle for stocks (ascending resistance is the hardest to break through and usually requires heavier conviction/volume). Obviously, it wouldn’t be a great sign if the index once again fell from around the current level, particularly if in the process it violated the rising support line that connects the December and August lows (green line). That would send up a real red flag given the “rising wedge-ish” chart pattern.
Not Necessarily the “End of the Bull Market”
That major ascending resistance line may look scary, but there have been other times during this secular bull market when similar lines were in play. Breakouts above the lines occurred in late 2013 and late 2017, proving that it is possible to overcome ascending resistance. It has also been common for the S&P 500 to “hug” the lines for several weeks, not breaking above them, but also not falling too far below them. That is a possibility here, too.
Areas to Watch are Clear
The good news is that we do have very clear support and resistance areas to watch on the S&P 500 chart. Ideally, the index now stays above 2940 and can breakout above the upper resistance line. Staying above the green areas would be a positive, while breaking below them would be a clear negative.
Russell 2000 Back to Top of Trading Range
Meanwhile, the small cap Russell 2000 has returned back up to the top of the trading range it’s mostly been in for much of the last year. Small caps have outperformed large caps off the recent lows, which is usually a positive sign for the broad market, but now we need the Russell 2000 to cleanly break above the top of the trading range and put in a more sustained period of performance. This would go a long way in helping breadth readings and indicating the secular bull market is alive and well.
Not Good if Semis Fall From Here
One potential cause for concern would be in the Semiconductor Index started to fall from its current level (h/t to Jesse Stine for pointing this out). The $SOX is flirting with its upper weekly Bollinger Band and the zone where it’s topped out twice before, all while seeing lower peaks in its RSI indicator in the bottom panel (indicating slowing momentum). Since the $SOX often acts as a leading indicator for the broad market, a triple top here would not be good and would suggest that further weakness in other areas of the market could follow. Alternatively, a breakout above the resistance zone would be a massive positive.
Holding for the Long Term is Tough
As evidence of what I wrote earlier, it is EXTREMELY difficult to hold a stock for the long term, even when you feel strongly about its future prospects. Amazon, for example, has returned over 1500% over the last 20 years, but there have been massive declines along the way that have had to be endured to get that full performance. Big money can be made as a long term investor, but not many people have the conviction to hold through thick or thin.
Oil Making Moves
The big market story of the past few days is clearly the attack on Saudi Arabia oil production which made both Brent and WTI prices shoot up. That move broke WTI out from its almost one-year downtrend, but prices have since fallen back down. The situation is still fluid, but from a technical perspective the area between $64-$66 still looks like resistance and the mid-$50s seems to be where oil feels the most comfortable for now. It’s worth watching oil closely, particularly for the Energy sector which finally got a much-needed shot in the arm with this quick increase in prices.
Higher Oil Has Been Better for Stocks Recently
High oil prices frighten many people, especially when bringing back memories of the extremely high prices prior to the Financial Crisis. However, oil in the $50-$70 range hasn’t been much of a burden and over the last couple of years there has largely been a positive correlation between oil and the S&P 500, meaning both have risen and fallen together. If that continues to hold, any further increase in oil may be a good thing for stocks on the whole.
Energy Sector Looks Interesting
While the oil shock may just be transitory, the Energy sector does look interesting from a technical perspective regardless. It has broken its downtrend from over the past year and while it did make a lower low in August compared to May, it did so with a higher RSI reading (a positive divergence). It’s worth keeping an eye on just in case oil doesn’t fade and the sector can finally put in a period of outperformance.
Industrials Trying to Break Out
Also worth keeping an eye on is that the Industrial sector could be in the process of creating a major breakout from an almost two-year trading range. It broke out a couple of sessions ago but since then hasn’t really accelerated higher. A false breakout would not be a good signal, but it looks like the Industrials are at least trying to stay above the breakout point, as they closed above it yesterday. A clean breakout would bode well for the broad market.
Breadth Holding Up
While the averages remain just below major resistance, breadth continues to hang in there. In fact, the percentage of stocks on the NASDAQ above the 200-day moving average just hit the highest level since the decline last fall.
Breadth Holding Up II
Likewise, the more sensitive percentage of stocks above the 50-day moving average on the NYSE also continues to creep up toward 75%, reflecting broad-based strength.
Breadth Holding Up III
There are still more stocks making new 52-week highs than 52-week lows across the major U.S. exchanges, as well.
Trade Ideas
Momentum has slowed over the last week in the sessions leading up to today’s Fed announcement, which has made for some boring trading. I would suggest not entering new trades before the announcement just in case, and then reevaluating afterward.
When I look for trades, I am looking for stocks I think can move in the direction I want them to go quickly while limiting my downside if I am wrong. I expect to be wrong a decent amount of the time given the tight stops, but the idea is that the winners should more than pay for the losers. There is an opportunity cost to holding a position, as the capital allocated to it prevents you from using that capital in another position, so if I enter a stock and it doesn’t quickly do what I think it should I may cut it even though a stop or profit target isn’t hit. Likewise, I usually move my stop up to my breakeven point once the trade starts to go in my favor in order to prevent a winning trade to turn into a losing trade. Understandably, my trading strategy might not fit your trading/investing strategy, but the trades highlighted in this report are the kinds that I typically look for.
Current Open Positions in Personal Accounts (this changes daily): Long BIDU, Long LABU, Long DNR
LONG: SunPower Corp. (SPWR)
There’s not much that looks outstanding right now ahead of the Fed announcement, but Solar stocks have been hot lately, both before the recent oil spike and afterward. SPWR appears to be the one in the most demand, and while it’s a little stretched in the near term after jumping 12% yesterday, it is still coming off a 30% decline in recent weeks and continues to attract strong volume. Pullbacks to $13.50-$14 would be particularly interesting to me, though I’d suggest using a smaller than typical position size given the volatility.
