Everybody likes it when an asset that they hold goes up in price. In fact, the more the better. But only to a point as it turns out. When price gets carried away to the upside – we trader types typically refer to it as a “going parabolic”, i.e., a situation when prices are essentially rising straight up – it almost invariably ends very badly. We have seen a couple of examples recently.
Palladium
Palladium is a metal that according to Bloomberg’s “About 85% of palladium ends up in the exhaust systems in cars, where it helps turn toxic pollutants into less-harmful carbon dioxide and water vapor. It is also used in electronics, dentistry, medicine, hydrogen purification, chemical applications, groundwater treatment, and jewelry. Palladium is a key component of fuel cells, which react hydrogen with oxygen to produce electricity, heat, and water.”
And it was pretty hot stuff for some time. At least until it wasn’t. As a proxy we will look at the ETF ticker symbol PALL, which attempts to track the price of palladium.
*From January 2016 into January 2018, PALL rose +139%
*In the next 7 months it declined by -26%
*And then the fun really began – Between August 2018 and February 2020 PALL rose +245%, with a +110% gain occurring in the final 5+ months of the advance
What a time it was. Until it wasn’t anymore.
Since peaking at $273.16 a share on 2/27/2020, PALL plunged -50% in just 12 trading days. To put it another way, it gave back an entire year’s worth of gains in just 12 trading days.
Was there any way to see this coming? Maybe. In Figure 1 we see a monthly chart with an indicator called “RSI32” in the bottom clip. This indicator is derived by taking the 2-month average of the standard 3-month Relative Strength Index (RSI).
During the panic sell-off in the stock market in recent weeks, treasury bonds became very popular as a “safe haven” as investors piled out of stocks and into the “safety” of U.S. Treasuries. What too many investors appeared to forget in their haste was that long-term treasury can be extremely volatile (for the record, short and intermediate term treasuries are much less volatile than long-term bonds and are much better suited to act as a safe haven). Likewise – just an opinion – buying a 30-year bond paying 1% per year is not entirely unlike buying a stock index fund when the market P/E Ratio is over 30 – there just isn’t a lot of underlying value there. So you are essentially betting on a continuation of the current trend and NOT on the ultimate realization of the underlying value – because there really isn’t any.
Anyway, Figure 3 displays a monthly chart of ticker TLT – an ETF that tracks the long-term treasury – with the RSI32 indicator in the bottom clip.
Bond price movement is typically not as extreme and volatile as Palladium, so for bonds a RSI32 reading above 80 typically indicates that potential trouble may lie ahead.
As of the close of 3/17/20, TLT was almost -15% off of its high in just 6 trading days. We’ll see where it goes from here.
Tesla (Ticker TSLA)
Anytime you see what is essentially a manufacturing company – no matter how “hot”, “hip”, or “cool” the product they build – go up 200% in 2 months’ time, the proper response is NOT giddy delight. The proper response is:
*If you DO own the stock, either set a trailing stop or take some profits immediately and set a trailing stop for the rest
*If you DO NOT own the stock, DO NOT allow yourself to get sucked in
Take TSLA in Figure 4 for instance. By February 2020 TSLA was up almost 200% in 2 months and almost 450% in 8 months. The RSI32 indicator was above 96 – a stark warning sign.
19 trading days after making its closing high, TSLA is down -59%.
Typically, the security in question gives back months – or in some case, years – worth of gains in a shockingly short period of time.
Beware the parabola.
Jay Kaeppel
Disclaimer: The information, opinions and ideas expressed herein are for informational and educational purposes only and are based on research conducted and presented solely by the author. The information presented does not represent the views of the author only and does not constitute a complete description of any investment service. In addition, nothing presented herein should be construed as investment advice, as an advertisement or offering of investment advisory services, or as an offer to sell or a solicitation to buy any security. The data presented herein were obtained from various third-party sources. While the data is believed to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information. International investments are subject to additional risks such as currency fluctuations, political instability and the potential for illiquid markets. Past performance is no guarantee of future results. There is risk of loss in all trading. Back tested performance does not represent actual performance and should not be interpreted as an indication of such performance. Also, back tested performance results have certain inherent limitations and differs from actual performance because it is achieved with the benefit of hindsight.
To put this piece in context please refer to Part I here.
Part I detailed the Good News (the stock market is still very much in a bullish trend and may very well continue to be for some time) and touched on one piece of Bad News (the market is overvalued on a long-term valuation basis).
The Next Piece of Bad News: The “Early Lull”
In my book, Seasonal Stock Market Trends, I wrote about something called the Decennial Pattern, that highlights the action of the stock market in a “typical” decade.
The Four Parts of the “Typical Decade” are:
The Early Lull: Market often struggles in first 2.5 years of a decade
The Mid-Decade Rally: Market typically rallies in the middle of a decade – particularly between Oct 1 Year “4” and Mar 31 Year “6”
The 7-8 Decline: Market often experiences a sharp decline somewhere in the Year “7” to Year “8” period
The Late Rally: Market often rallies strongly into the end of the decade.
We are now in the “Early Lull” period. This in no way “guarantees” trouble in the stock market in the next two years. But it does offer a strong “suggestion”, particularly when we focus only on decades since 1900 that started with an Election Year (which is where we are now) – 1900, 1920, 1940, 1960, 1980, 2000.
As you can see in Figures 5 and 6, each of these 6 2.5-year decade opening periods witnessed a market decline – -14% on average and -63% cumulative. Once again, no guarantee that 2020 into mid 2022 will show weakness, but….. the warning sign is there
Figure 5 – Dow price performance first 2.5 years of decades that open with a Presidential Election Year (1900-present)
Figure 6 – Cumulative Dow price performance first 2.5 years of decades that open with a Presidential Election Year (1900-present)
Summary
Repeating now: the trend of the stock market is presently “Up”.
Therefore:
*The most prudent thing to do today is to avoid all of the “news generated” worry and angst and enjoy the trend.
*The second most prudent thing to do is to acknowledge that this up trend will NOT last forever, and to prepare – at least mentally – for what you will do when that eventuality transpires, i.e., take a moment to locate the nearest exit.
Stay tuned for Part III
Jay Kaeppel
Disclaimer: The information, opinions and ideas expressed herein are for informational and educational purposes only and are based on research conducted and presented solely by the author. The information presented does not represent the views of the author only and does not constitute a complete description of any investment service. In addition, nothing presented herein should be construed as investment advice, as an advertisement or offering of investment advisory services, or as an offer to sell or a solicitation to buy any security. The data presented herein were obtained from various third-party sources. While the data is believed to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information. International investments are subject to additional risks such as currency fluctuations, political instability and the potential for illiquid markets. Past performance is no guarantee of future results. There is risk of loss in all trading. Back tested performance does not represent actual performance and should not be interpreted as an indication of such performance. Also, back tested performance results have certain inherent limitations and differs from actual performance because it is achieved with the benefit of hindsight.
OK, so this particular piece clearly does NOT qualify as “timely”. Hey, they can’t all be “time critical, table-pounding, you must act now” missives. In any event, as part of a larger project regarding trends and seasonality in the market, I figured something out – we “quantitative analyst types” refer to this as “progress.”
So here goes.
The Month of October in the Stock Market
The month of October in the stock market is something of a paradox. Many investors refer to it as “Crash Month” – which is understandable given the action in 1929, 1978, 1979, 1987, 1997, 2008 and 2018. Yet others refer to it as the “Bear Killer” month since a number of bear market declines have bottomed out and/r reversed during October. Further complicating matters is that October has showed:
*A gain 61% of the time
*An average monthly gain of +0.95%
*A median monthly gain of +1.18%
Figure 1 displays the monthly price return for the S&P 500 Index during every October starting in 1945.
Figure 1 – S&P 500 Index October Monthly % +(-)
Figure 2 displays the cumulative % price gain achieved by holding the S&P 500 Index ONLY during the month of October every year starting in 1945.
Figure 2 – S&P 500 Index Cumulative October % +(-)
So, you see the paradox. To simply sit out the market every October means giving up a fair amount of return over time (not to mention the logistical and tax implications of “selling everything” on Sep 30 and buying back in on Oct 31). At the same time, October can be a helluva scary place to be from time to time.
One Possible Solution – The Decennial Pattern
In my book “Seasonal Stock Market Trends” I have a section that talks about the action of the stock market across the average decade. The first year (ex., 2010) is Year “0”, the second year (ex., 2011) is Year “1”, etc.
In a nutshell, there tends to be:
The Early Lull: Often there is weakness starting in Year “0” into mid Year “2”
The Mid-Decade Rally: Particularly strong during late Year “4” into early Year “6”
The 7-8-9 Decline: Often there is a significant pullback somewhere in the during Years “7” or “8” or “9”
The Late Rally: Decades often end with great strength
Figures 3 and 4 display this pattern over the past two decades.
(Charts courtesy of WinWayCharts)
Figure 3 – Decennial Pattern: 2010-2019
(Charts courtesy of WinWayCharts)
Figure 4 – Decennial Pattern: 2000-2009
Focusing on October
So now let’s look at October performance based on the Year of the Decade. The results appear in Figure 5. To be clear, Year 0 cumulates the October % +(-) for the S&P 500 Index during 1950, 1960, 1970, etc. Year 9 cumulates the October % +(-) for the S&P 500 index during 1949, 1959, 1969, 1979, etc.
Figure 5 – October S&P 500 Index cumulative % +(-) by Year of Decade
What we see is that – apparently – much of the “7-8-9 Decline” takes place in October, as Years “7” and “8” of the decade are the only ones that show a net loss for October.
Let’s highlight this another way. Figure 6 displays the cumulative % return for the S&P 500 Index during October during all years EXCEPT those ending “7” or “8” versus the cumulative % return for the S&P 500 Index during October during ONLY years ending in “7” or “8”.
Figure 6 – S&P 500 cumulative October % +(-); Years 7 and 8 of decade versus All Other Years of Decade
For the record:
*October during Years “7” and “8” lost -39%
*October during all other Years gained +196%
Summary
So, does this mean that October is now “green-lighted” as bullish until 2027? Not necessarily. As always, that pesky “past performance is no guarantee of future results” phrase looms large.
But for an investor looking to maximize long-term profits while also attempting to avoid potential pain along the way, the October 7-8 pattern is something to file away for future reference.
Jay Kaeppel
Disclaimer: The information, opinions and ideas expressed herein are for informational and educational purposes only and are based on research conducted and presented solely by the author. The information presented does not represent the views of the author only and does not constitute a complete description of any investment service. In addition, nothing presented herein should be construed as investment advice, as an advertisement or offering of investment advisory services, or as an offer to sell or a solicitation to buy any security. The data presented herein were obtained from various third-party sources. While the data is believed to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information. International investments are subject to additional risks such as currency fluctuations, political instability and the potential for illiquid markets. Past performance is no guarantee of future results. There is risk of loss in all trading. Back tested performance does not represent actual performance and should not be interpreted as an indication of such performance. Also, back tested performance results have certain inherent limitations and differs from actual performance because it is achieved with the benefit of hindsight.
3-26-20 saw the market on the third day of a rebound from the low of 18213 on 3-23-20. The chart below shows the Fibonacci retracements from the recent high to this low. Since that time prices have been a narrow range for this volatile market
The retracement hit the 38.2% level and this level can offer resistance. The market is down again and could be we are headed down to retest at or near the last low.
If we rally passes the 38.2% the next resistance level will be at 23775 or so at the 50% retracement level.
Market Timing signals
The Market Timing system issued a 99-1 up signal on 3-10-20, the chart below shows the signal. The Phase indicator changing direction in the direction of the signal (moving down then moves up) provides confirmation market Timing signals. IN this case that didn’t happen.
Another up signal 99-1 fired on 3-24-20 and this time the phase turned up the same day and confirmed the signal.
Here are 3 of the bullish rules that fired to create this high up signal
The 21 day stochastic has advanced and crossed the 20% line and the price phase indicator is also increasing. In this weakly downtrending market this is taken as a strong bullish signal suggesting an increase in prices.
Volume accumulation percentage is increasing and the 21 day stochastic has moved above the 20% line. In this downtrending market, this is taken as a strong bullish signal that could be followed by an upward price movement.
The price phase indicator is negative but volume accumulation has started to advance. This is a non-conformation that, regardless of the type of market, is a bullish signal which usually results in an upward movement of the market.
The counter trend AI system that generates these signals can be early in their firing. While the market moved up 2000 a nice move in most markets, in prior trading environments this would have taken a number of weeks, in our current volatility the market moved from the up signal in 2 days.
I haven’t written a lot lately. Mostly I guess because there doesn’t seem to be a lot new to say. As you can see in Figure 1, the major market indexes are in an uptrend. All 4 (Dow, S&P 500, Russell 2000 and Nasdaq 100) are above their respective 200-day MA’s and all but Russell 2000 have made new all-time highs.
As you can see in Figure 2, my market “bellwethers” are still slightly mixed. Semiconductors are above their 200-day MA and have broken out to a new high, Transports and the Value Line Index (a broad measure of the stock market) are holding above their 200-day MA’s but are well off all-time highs, and the inverse VIX ETF ticker ZIV is in a downtrend (ideally it should trend higher with the overall stock market).
As you can see in Figure 3, Gold, Bonds and the U.S. Dollar are still holding in uptrends above their respective 200-day MA’s (although all have backed off of recent highs) and crude oil is sort of “nowhere”.
Like I said, nothing has really changed. So, at this point the real battle is that age-old conundrum of “Patience versus Complacency”. When the overall trend is clearly “Up” typically the best thing to do is essentially “nothing” (assuming you are already invested in the market). At the same time, the danger of extrapolating the current “good times” ad infinitum into the future always lurks nearby.
What we don’t want to see is:
*The major market averages breaking back down below their 200-day MA’s.
What we would like to see is:
*The Transports and the Value Line Index break out to new highs (this would be bullish confirmation rather the current potentially bearish divergence)
The Importance of New Highs in the Value Line Index
One development that would provide bullish confirmation for the stock market would be if the Value Line Geometric Index were to rally to a new 12-month high. It tends to be a bullish sign when this index reaches a new 12-month high after not having done so for at least 12-months.
Figure 4 displays the cumulative growth for the index for all trading days within 18 months of the first 12-month new high after at least 12-months without one.
Figure 4 – Cumulative growth for Value Line Geometric Index within 18-months of a new 12-month high
Figure 5 displays the cumulative growth for the index for all other trading days.
Figure 5 – Cumulative growth for Value Line Geometric Index during all other trading days
In Figure 4 we see that a bullish development (the first 12-month new high in at least 12 months) is typically followed by more bullish developments. In Figure 5 we see that all other trading days essentially amount to nothing.
Figure 6 displays the Value Line Geometric Index with the relevant new highs highlighted.
The trend at this very moment is “Up.” So sit back, relax and enjoy the ride. Just don’t ever forget that the ride WILL NOT last forever. If the Value Line Geometric Index (and also the Russell 2000 and the Dow Transports) joins the party then history suggests the party will be extended. If they don’t, the party may end sooner than expected.
So pay attention.
Jay Kaeppel
Disclaimer: The information, opinions and ideas expressed herein are for informational and educational purposes only and are based on research conducted and presented solely by the author. The information presented does not represent the views of the author only and does not constitute a complete description of any investment service. In addition, nothing presented herein should be construed as investment advice, as an advertisement or offering of investment advisory services, or as an offer to sell or a solicitation to buy any security. The data presented herein were obtained from various third-party sources. While the data is believed to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information. International investments are subject to additional risks such as currency fluctuations, political instability and the potential for illiquid markets. Past performance is no guarantee of future results. There is risk of loss in all trading. Back tested performance does not represent actual performance and should not be interpreted as an indication of such performance. Also, back tested performance results have certain inherent limitations and differs from actual performance because it is achieved with the benefit of hindsight.
I keep seeing headlines about the “imminent” re-emergence of commodities as a viable investment as an asset class. And as I wrote about here, I mostly agree wholeheartedly that “the worn will turn” at some point in the years ahead, as commodities are historically far undervalued relative to stocks.
The timing of all of this is another story. Fortunately, it is a fairly short and simple story. In a nutshell, it goes like this:
*As long as the U.S. Dollar remains strong, don’t bet heavy on commodities.
The End
Well not exactly.
The 2019 Anomaly
The Year 2019 was something of an anomaly as both the U.S. Dollar and precious metals such as gold and silver rallied. This type of action is most unusual. Historically gold and silver have had a highly inverse correlation to the dollar. So, the idea that both the U.S. Dollar AND commodities (including those beyond just precious metals) will continue to rise is not likely correct.
Commodities as an Asset Class
When we are talking “commodities as an asset class” we are talking about more than just metals. We are also talking about more than just energy products.
The most popular commodity ETFs are DBC and GSG as they are more heavily traded than most others. And they are fine trading vehicles. One thing to note is that both (and most other “me too” commodity ETFs) have a heavy concentration in energies. This is not inappropriate given the reality that most of the industrialized world (despite all the talk of climate change) still runs on traditional fossil fuel-based energy.
But to get a broader picture of “commodities as an asset class” I focus on ticker RJI (ELEMENTS Linked to the Rogers International Commodity Index – Total Return) which diversifies roughly as follows:
Agriculture 40.90%
Energy 24.36%
Industrial Metals 16.67%
Precious Metals 14.23%
Livestock 3.85%
Note that these allocations can change over time, but the point is that RJI has much more exposure beyond the energy class of assets than alot of other commodity ETFs.
RJI vs. the Dollar
As a proxy for the U.S. Dollar we will use ticker UUP (Invesco DB US Dollar Index Bullish Fund). Figure 1 displays the % gain/loss for UUP (blue line) versus RJI (orange line) since mid-2008.
Figure 1 – UUP versus RJI; Cumulative Return using weekly closing prices; May-2008-Sep-2019
*Since May of 2008 UUP has gained +17.2%
*Since May of 2008 RJI has lost -60%
The correlation in price action between these two ETFs since 2008 is -0.76 (a correlation of -1.00 means they are perfectly inverse), so clearly there is (typically) a high degree of inverse correlation between the U.S. dollar and “commodities”.
Next, we will apply an indicator that I have dubbed “MACD4010501” (Note to myself: come up with a better name). The calculations for this indicator will appear at the end of the article (but it is basically a 40-period exponential average minus a 105-period exponential average). In Figure 2 we see a weekly chart of ticker UUP with this MACD indicator in the top clip and a weekly chart of ticker RJI in the bottom clip.
Figure 2 – UUP with Jay’s MACD Indicator versus ticker RJI (courtesy WinWayCharts )
Interpretation is simple:
*when the MACD indicator applied to UUP is declining, this is bullish for RJI
*when the MACD indicator applied to UUP is rising, this is bearish for RJI.
Figure 3 displays the growth of equity achieved by holding RJI (using weekly closing price data) when the UUP MACD Indicator is declining (i.e., RJI is bullish blue line in Figure 3) versus when the UUP MACD Indicator is rising (i.e., RJI is bearish orange line in Figure 3).
Figure 3 – RJI cumulative performance based on whether MACD indicator for ticker UUP is falling (bullish for RJI) of rising (bearish for RJI)
In sum:
*RJI gained +45.8% when the UUP MACD indicator was falling
*RJI lost -72.3% when the UUP MACD indicator was rising
The bottom line is that RJI rarely makes much upside headway when the UUP MACD Indicator is rising (i.e., is bearish for RJI).
Summary
Commodities as an asset class are extremely undervalued on a historical basis compared to stocks. However, the important thing to remember is that “the worm is unlikely to turn” as long as the U.S. Dollar remains strong.
So, keep an eye on the U.S. Dollar for signs of weakness. That will be your sign that the time may be coming for commodities.
FYI: Code for Jay’s MACD4010501 Indicator (WinWayCharts TradingExpert EDS)
The indicator is essentially a 40-period exponential average minus a 105-period exponential average as shown below:
Define ss3 40.
Define L3 105.
ShortMACDMA3 is expavg([Close],ss3)*100.
LongMACDMA3 is expavg([Close],L3)*100.
MACD4010501 is ShortMACDMA3-LongMACDMA3.
Jay Kaeppel
Disclaimer: The information, opinions and ideas expressed herein are for informational and educational purposes only and are based on research conducted and presented solely by the author. The information presented does not represent the views of the author only and does not constitute a complete description of any investment service. In addition, nothing presented herein should be construed as investment advice, as an advertisement or offering of investment advisory services, or as an offer to sell or a solicitation to buy any security. The data presented herein were obtained from various third-party sources. While the data is believed to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information. International investments are subject to additional risks such as currency fluctuations, political instability and the potential for illiquid markets. Past performance is no guarantee of future results. There is risk of loss in all trading. Back tested performance does not represent actual performance and should not be interpreted as an indication of such performance. Also, back tested performance results have certain inherent limitations and differs from actual performance because it is achieved with the benefit of hindsight.
English