[Premium] Weekly Open Letter About The Current Market Environment

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Dear Members,

The rip-your-face-off rally in stock markets all over the world continues as the extreme bearish sentiment seen in the early days of 2016 unwinds to the upside. The strength first came out of the emerging markets, particularly Latin America and South Africa due to their mining exposure. We highlighted these areas in late January as the best way to take advantage of the counter-trend rally in stocks that we expected in the coming months. More recently, in the past 3 weeks, we have started to see the more developed markets, especially the United States take part in the rally worldwide that began on January 20th.

I’ve brought this day up several times since then, but I would just like to reiterate the importance of that January 20th date. This is when the majority of international stock market indexes and ETFs put in their 2016 bottoms. In addition, this is when the list of new 52-week lows on the New York Stock Exchange peaked. Let’s remember that although the S&P500 and Nasdaq Composite made new lows last month, we saw half the amount of stocks on the new 52-week low list as there was at the January 20th low. This was the market bottom, not February.

In our letter to members in mid-February, we highlighted the developed markets around the world, particularly the U.S., as the next group of nations to join the rally and try to play catch up to Emerging markets, and more specifically Latin America. The best way to take advantage of this was not through the large-cap indexes, but rather through the smaller-cap Russell2000 ($IWM) and Russell Micro-cap ($IWC) indexes. So far both of these trades are working out beautifully and expect higher prices in both of these to come soon. The most important part about these trades was not that we were right, but that the risk was very well-defined. This is what is most important folks: it’s not about being right, it’s about making money.

I really think that it’s appropriate to reiterate how important it is to define your time horizon. As you guys know, I had been a monster bear towards both the U.S. and International Stock Markets for some time. We got the selling that we wanted to see in December and January, and a lot of our tactical downside targets were achieved (on or around January 20th). Although some U.S. Indexes and Sectors went on to consolidate a bit since then before going on to rally, like Airlines ($XAL) for example, the bottom was put in this January. There were so many bullish momentum divergences all over the world at or around those January lows, that it was impossible to stay bearish. There was enough evidence globally to not only change our stance to neutral from bearish, but in many cases, be very bullish and look to buy stocks after covering all short positions in January when those targets were first achieved.

There are many cases out there where big time bears, like I was, did not change their tune, or were too close-minded to not accept that a counter-trend rally of this magnitude was in the cards. This is where the value in looking globally really comes into play. Their stubbornness has crushed their investors over the past few months in a similar manner to the long-only mentality that kills investors during market corrections. Let’s remember that it was not the S&P500 or Dow Jones Industrial Average that turned us bullish in January. It was the weight-of-the-evidence globally that suggested to us it was time to get very aggressively long. Most importantly, the risk levels were extremely well-defined. It was okay to be wrong. Fortunately things worked out in our favor and we have just witnessed one of the most powerful global rallies of all time, particularly in Latin America ($ILF) and South Africa ($EZA), which were our two favorites. Even if you don’t trade globally, using evidence found around the world really helps make decisions within your own country’s borders. This is one of the most valuable parts of my process.

A few names that we highlighted within the U.S. Stock market to take advantage of this rally were Twitter ($TWTR) and Yahoo ($YHOO). Again, the risk levels were very well-defined in both of these stocks. We want to be taking profits in Yahoo as it hit out upside target today. Twitter still has more room to run even though we’ve already seen a 20% rally from our key entry level. I think we still have another 15-20% of upside left. GoPro ($GPRO) is the other beaten down name we’ve mentioned and I still believe we head a lot higher. I would not be long if prices are below last week’s lows. The risk management levels in all 3 of these are/were very well-defined. Finally, Apple ($AAPL) was a stock we liked and I would still be a buyer on any weakness. I think we see $108 before all is said and done.

I still would not mess with the S&P500 or Dow Jones Industrial Average. Remember, the U.S. is the big underperformer in this rally, particularly the large-caps. So the places to be long are neither of those. We still prefer to be in the Emerging Markets and the smaller-cap U.S. Indexes like the Russell2000 and Russell Micro-cap indexes. Also in developed markets is Europe ($FEZ) and Germany ($EWG). We still like both of those on the long side, as we have over the past few weeks.

We have been in the camp since January that Emerging Markets outperform the U.S. Stock market. We still like this moving forward as price continues to confirm everything that we saw coming since January. In fact, the MSCI Emerging markets Index Fund closed at a new year-to-date high today vs the S&P500. The Latin America 40 Index closed today at a new 3-month high relative to the S&P500. They are also reaching those highs on their own, but I would like to reiterate their obnoxious outperformance over U.S. equities. Also something I find funny is that you don’t hear anyone talking about this. When was the last time you read or saw on the TV that Chile is up 19% since the January lows, Peru is up 30%, Colombia is up 30% or that South Africa is up 27%? These were all country indexes and ETFs that we pointed to and have wanted to own since January. As usual, price leads and news follows. I’m sure we’ll be hearing plenty about the performance of these mining led nations just as it’s time for us to be taking our profits as we hit our targets.

U.S. Interest rates got crushed in January and into February just as we had hoped. This was one of our favorite trades coming into the New Year: Buy U.S. Treasury Bonds and buy stocks with higher yields relative to the S&P500. This obviously worked out great as interest rates collapsed in the face of wall street economists all telling us they were going higher. This continues to be a terrific group to fade as a consensus. No one has been more wrong over the past few years than wall street economists. Maybe that’s why they’re economists and not allowed to actually trade real money. Meanwhile, two weeks ago, all of our downside objectives in rates were hit (1.65% in 10-year yield) and we wanted to sell all of our bonds and interest rate sensitive trades, like utility stocks. Since then rates have exploded higher sending bond prices tumbling and the former outperformance out of utilities has disappeared. We still do not want to be buying bonds and further evidence suggests that we should see north of 2.1% in the U.S. 10-year yield, which is currently still under 1.85%.

The trade today is buying High Yield Junk Bonds. I keep hearing how there is a crisis going on in this market, but price action and momentum suggests that this is still a place we want to be buying aggressively. I think the High Yield Bond Fund $HYG can see $84 here in the short-term and ultimately $86. More importantly, relative to the safe-haven U.S. Treasury Bond market, I believe the junk bonds keep outperforming after putting in a bottom last month. This bottom in the ratio ($HYG vs $TLT) just so happened to have been exactly the 2008 lows. This is not something we see as a coincidence, but rather more evidence to suggest a long position in both the High Yield Bonds as well as a pair against U.S. Treasury Bonds is most appropriate moving forward. I believe this is all part of the global “risk-on”, rally that got started on January 20th and should continue through March. I hate using the phrase, “risk-on”, but in this case it’s the best way to describe it. Sorry….I know….

Even though some of these markets have gone straight up since January, some of them have seen some consolidation and are now starting to perk up. Two sectors in particular that fit this description and I think are worth highlighting are Biotechnology and Regional Banks. We had been very bearish of Biotech since last summer, and in January our target of $50 in the Biotech fund ($XBI) was hit where we wanted to cover all short positions. After another month or so of backing and filling, we broke back above the $50 level this week which is where we wanted to get long. I would still only be in Biotech if we are above that $50 level and looking to take profits above $60, representing a 20% rally, which more than justifies the risk being taken. Within that space I think Biogen $BIIB looks great and heading towards $310 where we want to be taking profits. Risk management-wise, I would not own this if we are below the October lows. This makes the risk/reward very well-defined.

Similarly, Regional Banks ($KRE) had been one of our favorite short positions since November after confirming that failed breakout and bearish momentum divergence. Our downside targets were hit in January where we wanted to be covering all shorts. Since then, we have seen some backing and filling while momentum had an opportunity to diverge positively. We have only wanted to be long of Regional Banks if prices were above $35.20 and that breakout took place this week. I think we continue to see this squeeze higher into March and want to be taking profits as we approach $41. There are other U.S. Sectors and Sub-sectors with similar risk/reward profiles and all of them can be found in the Chartbook as always. These are just 2 good examples that tell this story well.

Moving on to precious metals, I have to reiterate just how impressed I am by these guys. What was just a short-term bullish trade that we wanted to put on in January has turned into what I think can be a new secular bull market for precious metals and precious metal stocks. Looking at Gold specifically, the coming week should be a big tell for just how powerful of a trend this is or can be. This is certainly a bullish continuation pattern in price that has developed over the last few weeks. A bearish resolution to this consolidation would signal to us that a pull back towards 1140 is coming. Although I think this is the lower probability outcome, it is one that we are open-minded to for sure and would welcome the pull-back to buy Gold again near 1140. The higher probability outcome is that the resolution out of this multi-week range will be in the direction of the underlying trend, which in this case is higher. The next stop is over $1300 and tactically at this point I would only be long if we are above 1240. Below that increases the likelihood that the resolution is lower. It’s not the easiest or cleanest situation, but one that I find very interesting and it’s what it is. We have to deal with the market that we have, not the market that we want. It’s not always clean like the Russell2000 & Russell Micro-cap indexes that gave us super clean outs in the case that we were wrong a couple of weeks ago.

Also in that group is Palladium. All of our downside targets have been hit in this metal and momentum is diverging positively on multiple timeframes in a very similar way that emerging markets and Latin America did back in January. We want to own Palladium if prices are above $523 and look to take profits near $600 (Futures are $PA_F and the ETF is $PALL). Silver (/SI or $SLV) is another one we want to watch as it approaches the downtrend line from those epic 2011 highs. A breakout above that downtrend should coincide with an upside resolution in gold. This development would be extremely constructive for the entire precious metals space. This is reason enough to pay attention.

I think we get a monster breakout in Energy stocks relative to the S&P500. Energy was one of the most, if not the most, hated sector in America coming into the year. This one bottomed out relative to S&Ps back on….you guessed it…..January 20th. This is a key date guys. I think we are going A LOT higher in energy, both on its own and relative to S&Ps. I would still be an aggressive buyer of $XLE, which represents the entire group, and also the Exploration and Production stocks ($XOP) as my favorite sub-sector.

This rally in Energy stocks continuing should coincide with Crude Oil continuing its rally. We’ve liked this commodity for a while and still believe it goes a lot higher. I think we ultimately see $50 Crude Oil, but looking shorter-term I would be taking tactical profits between $38-$40. We have also been in the bullish camp in Copper. We’ve wanted to own this one and still think we see $2.30 where we want to be taking tactical profits.

To bring this all together and getting back to the “weight-of-the-evidence” approach, a rally in Australian Dollars fits right into this global/emerging/commodity theme. Our downside targets in $AUD/USD were hit last summer near $0.73 where we wanted to be covering all short positions. Since then we have consolidated nicely and put together a heck of a base. I believe that everything we are seeing globally suggests an upside breakout is coming and we want to be buyers if we’re above $0.73 for a move back up above $0.81. I think the bullish momentum divergences we’re seeing in $AUD/JPY, which is Australian Dollars vs Japanese Yen, instead of vs U.S. Dollars, suggests we get an upside breakout there too. The range over the last 3 weeks should resolve higher and we want to be buyers of $AUD/JPY taking profits near $0.87. Also, the Mexican Peso continues to rip higher and is one we’ve liked for a few weeks. I still like it and think it continues higher.

As you can tell, the recent rally has not scared me from staying the course. We’ve been bullish since January and everything we’ve seen since then, not only confirms our thesis, but suggests there is more coming as money rotates into new sectors and countries, Regional banks, Biotech, Germany, Japan, etc. I still believe this is just a counter-trend rally within a much larger structural problem globally, but one big enough to take advantage of over the past 6 weeks and one we want to continue to try and profit from through the end of the first quarter.

That’s it for now. Please feel free to write with comments or questions.

Cheers,

JC

PS – The March Members-Only Conference Call will be held on Wednesday March 9, 2016 at 7PM ET. Please register here. As always a video recording of the call will be available to all members, but we highly encourage you to try and make the live call in order to interact and ask questions.

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