[Premium] Weekly Open Letter About The Current Market Environment

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Dear Members,

The counter-trend rally in stocks that began last month is really starting to kick into high gear. We expected the U.S. to underperform during this process, while Emerging Markets lead, and this is precisely what is occurring. While global markets, particularly emerging economies have ripped higher over the past 4 weeks, the U.S. and other developed nations (Europe, Japan, etc) are now playing catch-up. We continue to think that stocks still head a lot higher and that emerging markets will continue their dominance over the U.S. and other developed economies around the world.

In the letter to members on January 26th, we highlighted a list of countries that were putting in bullish momentum divergences on both weekly and daily timeframes. We suggested that these would be the leaders going forward when compared to countries where this was not the case. A large percentage of the ones that fit this description were on the emerging list. This was a big reason why we’ve felt over the past month that the best opportunities were outside of the U.S. This has certainly been the case since then, but we’ve had some interesting setups recently in some really beat up stocks in the U.S. that I think are worth mentioning

Three names that we’ve discussed on the long side have been Twitter, Yahoo and Apple. All 3 of these have been crushed and are in nasty bear markets. While sentiment was at or near bearish extremes in these stocks, momentum was putting in bullish momentum divergences while the media has been obsessing over who is Twitter’s CEO, or how bad of a job Marissa Mayer is doing and why Apple is not cooperating with the FBI and can no longer innovate. I don’t know what any of that nonsense has to do with these stocks and we prefer to chalk that up as noise made by people who are paid to make noise and not to make money in the market. For the rest of us who are paid to sell stocks higher than where we buy them, we focus on market behavior, not the TMZ of finance that is the majority of financial media today.

The levels for these 3 stocks remain exactly the same. We only own Twitter if prices are above 15.50, the January lows. We still only want to own Yahoo if the price is above $27.20, which was the September lows. And we only want to own Apple if it is above 97.35, which was resistance over the past 3 weeks. I still love the risk/reward profiles of all 3 of these. The risk is by far and away justified by the potential reward. Targets are 24.50 for $TWTR, $33 for $YHOO and $108 for $AAPL.

Another one that I’d like to add to this list is GoPro. I should have mentioned this one last week but did not want to overwhelm you guys with too many trade ideas. All of these are pretty much the same trade with similar risk/reward profiles. But I do love this one and falls right into that same category of extreme negative sentiment, bullish momentum divergences, and too much negative noise made by noisemakers who don’t get paid to make money in the market. We only want to own $GPRO if it is above 11.75 which has been resistance since last month. I would be taking profits above $20.

Meanwhile, bonds are getting smoked as interest rates explode higher. We could not be happier to see this as last week all of our upside objectives were met. This has been a trade that we’ve liked for a long time as we expected U.S. and global interest rates to get destroyed sending treasury bond prices higher. We expected this to also make its way into the stock market as high dividend paying stocks would benefit if fixed income investors who could not get their yields in bonds had to turn to stocks to get their fix. Last week we made it perfectly clear that we wanted to sell all of our U.S. Treasury bond positions, whether $TLT, $TLT calls or 30-year futures $ZB_F. We also wanted all of the rate sensitive stocks, both absolute and relative to S&Ps, completely off our portfolios since our downside objectives in rates were hit (1.65% in 10s). I hope you guys listened because interest rates have exploded higher and anything bond related has been destroyed. This puts on a smile on our face.

When I first mentioned last month that we wanted to get long emerging markets very aggressively on both a relative and an absolute basis, South Africa was the one I pointed to as a favorite of mine. Since then, South Africa $EZA is up 13% and closed today at new year-to-date highs.  I fully expect this rally in South Africa to continue and we want to be taking profits near $51, another 8.5% higher from current levels. I also expect this to continue to outperform the U.S. markets as well.

Latin America has been area within the emerging space that we said would be the outperformer of that group, for once in its life. What has arguably been the worst place on planet earth over the last half decade has emerged as the new leader (pun intended).  Peru is up over 20% from last month’s lows, Chile is up 15%, Brazil up 16%, Colombia up 16% and Mexico is up a little over 10%. Remember that Mexico is the “least emerging” of the group and therefore comes with the least beta, volatility and risk when compared to the others. Think of Peru and Chile as the small or micro-caps of the group and Mexico as the relatively safer large-cap. Mexico would underperform on the way up, but outperform relative to the rest on the way down. This underperformance since last month makes perfect sense. Even still, Mexico has outpaced the U.S. stock market by 2 to 1 since last month’s lows, further evidence of just how much stronger emerging markets are compared with the U.S. and other developed nations.

One other thing I’d like to add about Mexico is the monster rally that’s been sparked in its currency, the Mexican Peso. Very similar to what we saw last month in emerging markets putting in bullish momentum divergences on both daily and weekly timeframes, the Mexican Peso has done just that on last week’s lows. Prices of Mexican Peso Futures briefly broke below the January lows and momentum made higher lows on both timeframes. The line in the sand is now the January low. We only want to own Mexican Pesos $6M_F if it is above 0530. I would be taking profits near 0585 as I think they still have a long way to go.

Also in the emerging space is China, speaking of terrible sentiment and too much noise made by noisemakers. We’ve wanted to be short China Large-cap stocks, specifically $FXI, for a while now. Our downside targets near $28 were finally hit over the past week where we wanted to be covering all short positions. Meanwhile, on those new lows, momentum put in higher lows, confirming bullish momentum divergences on both the weekly and daily timeframes. Based on our downside targets being achieved over the past week and momentum shifting, we now want to get long of China only if we are above this week’s lows. I think there could be at least another 20% of upside here. Another thing worth watching is the Shanghai Composite Index. If Shanghai can get and stay above the August lows we could see a monster squeeze in that market. This failed breakdown can be another catalyst to keep this counter-trend global stock market rally going. On the developed side of China, Hong Kong hit our downside target last month where we wanted to be covering all short positions. After some consolidation, we have now seen enough evidence to get us long the Hong Kong exchange traded fund $EWH only if we are above the August lows. I like the whole China theme here.

On the more developed side of markets, I noticed this week that a lot of our downside targets were being hit while momentum diverged positively on multiple timeframes. In other words, the action we’re seeing in the developed economies today is the exact same thing we saw in the emerging markets a month ago. Japan, for example, last week finally reached the $40 target in $DXJ that we had to the downside where we wanted to cover all short positions. This target was based on the 161.8% Fibonacci extension of the August-November rally. Meanwhile, Europe did the exact same thing last week. The Euro Stoxx 50 Index ETF $FEZ hit our downside target of $30.46, where we wanted to be covering all short positions. This target, like in Japan, was based on the 161.8% Fibonacci extension of the September-October rally. The interesting part of Europe, however, is that on the new lows last week, momentum put in a bullish momentum divergence on both daily and weekly timeframes. Based on this action, we want to be long of Europe here, specifically $FEZ, only if we are above that 30.46 level.

As a continuation of this bullish Developed Markets thesis, specifically Europe, Germany is one we want to own within that space. The German DAX Index also put in a bullish momentum divergence at last week’s lows. Meanwhile, the Germany exchange traded fund $EWG finally hit our downside target last week near $23, which was based on the 61.8% Fibonacci retracement of the 2011-2014 rally. This is where we wanted to be covering all short positions. Meanwhile, momentum put in a bullish momentum divergence on both the daily and the weekly timeframe. We therefore want to be aggressively long Germany if we are above $22.85 in $EWG.

In Japan, I do like that our downside targets were hit and we did want to cover all short positions, but I’m not convinced that we want to buy it just yet. I prefer buying Europe if you want to be long developed markets. The best way to be in Japan, in my opinion, is against America. In other words, long Japan / Short USA. The way to execute this is for every dollar long $DXJ you are short one dollar worth of $SPY. This spread is bouncing off the 2012 lows and we only want to be long of this spread if the ratio is above 0.2143 in DXJ/SPY. I think we can get back up above 0.24.

As far as the U.S. stock market is concerned, we wanted to be covering all of our short positions almost a month ago. Our tactical downside targets were hit, we stayed disciplined, and got out of the way. We preferred instead to err on the long side and only be long certain indexes against specific levels. Those were all clearly outlined in the Chartbook. I think the relative strength we’ve seen in smaller-cap stocks in the past week should continue. Specifically, we want to own the Russell2000 Small-cap index fund $IWM only if we are above $97.50. Looking even smaller on the capitalization-scale, we want to own the Russell Micro-cap index fund $IWC only if we are above $61.15. I think both of these have a lot more upside, particularly relative to their larger-cap counter-parts.

Also in the U.S. stock market, I’d like to mention that we are seeing some serious bullish activity in the casino stocks, particularly from a structural perspective. I would put these guys in a similar category as the Gold Miners: Terrible terrible disgusting bear markets, but after a solid month, could be at the start of a monster secular change. Wynn Resorts, Las Vegas Sands and MGM are three stocks that have been destroyed since late 2013-early 2014. $WYNN alone fell from $250 to $50 in less than 2 years losing 80% of its value. The recent breakout really stands out, especially from a longer-term perspective. I’m not ready to make any trades in this space just yet, but we 100% want to put these on our radar. I think we could be at the beginning of a major change in trend. Stay tuned…

I know I’ve said a lot of nice things in this letter and my tone has certainly shifted over the past month, but it has come for good reason. The international stock markets were giving us signals that were not as clear as they were in the U.S. stock market. This is why we use a global top/down approach. It’s much more efficient than closing our minds to coastal boundaries. This is 2016, let’s not be silly and narrow-minded like so many people decide to be. We strive to make profits globally, because we have that ability today that we did not have 20 years ago or 50 years ago.

Context: As bullish as I’ve been over the past month and as optimistic as these letters continue to be, structurally we’re still in vicious bear markets and we want to make sure you understand that this is just a counter-trend move within an ongoing downtrend. Fortunately, history has proven that counter-trend rallies tend to be the most explosive and most profitable. Based on what we’ve seen in the past month, this one is no different. We’re seeing monster moves higher all over the world, and now the U.S. and other developed nations are trying to catch up. I think they do well, but won’t catch up. Emerging remains the leader and we want to treat them that way until further notice.

That’s it for now. As always, feel free to write with questions or comments.

Cheers,

JC

Tags: $FEZ $DXJ $EWJ $NIKK $FXI $SSEC $TWTR $YHOO $GPRO $AAPL $TLT $ZB_F $TNX $TYX $EZA $EEM $ILF $EWZ $ECH $GXG $EWW $EPU $ILF $6M_F $EWG $DAX $IWM $IWC $WYNN $MGM $LVS $SPY

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