Tuesday was a special day for us stock market participants. We don't always have such a spectacular display of completed Bullish Engulfings on a single day. It was an amazing thing to watch. Last night I could barely sleep. I just wanted to come back and make sure that actually happened. Man, what a rush!
For those of you who are less enthusiastic about Bullish Engulfings, or "outside days" as they call them in the West, these things don't happen too often, and there are even fewer instances where they all take place in unison. We're pretty stoked about it, I gotta tell you. What we're referring to here specially is the fact that yesterday, the lows of the day in many cases were below the prior day's lows, but the highs and closing prices were both above the prior day's high. The double extreme here is evidence of an overwhelming amount of demand relative to supply. Here is what it looks like:
Brian Shannon is one of the first Technicians that I ever followed. I used to watch his YouTube videos as far back as 2006. Brian is a pioneer in Technical Analysis in the Social Media era. His book Technical Analysis Using Multiple Timeframes is one of the most important books I've ever read. In this episode @alphatrends walks us through his multi-timeframe approach and how that can be incorporated into your process regardless of time horizon. We discuss the current U.S. Stock Market environment including price behavior and sentiment. Since Brian is one of the highest authorities on the subject of Volume Weighted Average Price (VWAP) we couldn't help ourselves but get into the subject at length. This was a great conversation with someone who has been a mentor to a lot of us over many years.
You can data-mine all you want. Tell me the world is ending, the U.S. President is crazy, nuclear war is around the corner, the N.Y. Jets don't have a quarterback.....Whatever it is that you're using to justify your heavy cash positions or short exposure the past 18 months, just remember this: Stocks are hitting all-time highs. Let's go over this again: Stocks are not just hitting multi-month highs, or even 52-week highs. Stocks that are driven by supply and demand dynamics of investors all over the world are at the highest levels in the history of stocks.
So how do we define stocks? That's the tricky part. Is it the S&P500? Although it's only 1.4% away from an all-time high, and clearly in a strong uptrend defined by higher highs and higher lows, I would argue that it's only part of the equation. What about the Russell3000, which represents approximately 98% of all investable assets in the U.S. equities market? Although just 1.7% from its all-time high, it is still just representing 1 country. There has to be a better way.
The Dow Jones Transportation Average has been one of the best leading indicators for the direction of markets over the past few years. This index peaked in late 2014, six months before the S&P500 put in its top. The Transportation Average also bottomed out in January 2016, the month before the S&P500 finally made its bottom. Moving forward, we want to continue to give this index the weighting it deserves.
With the recent underperformance out of this group, let's dive in and see what is going on underneath the surface. Is this the beginning of a major sell-off in Transports, which would lead the rest of the market lower? Or has this just been a correction within a strong uptrending market?
It's hard to keep your emotions out of your portfolio decisions. Throughout evolution, the way we are built is to be horrible investors because we're hard-wired to make the exact opposite decision to what is right simply if our emotions are running high. That's just science. I've read a lot about this and discussed it with Doctors. It's a fascinating subject, particularly for someone who is interested in the behavior of markets. The first step to recovery is understanding that we have a problem right? We're designed to be terrible investors. After recognizing this flaw of ours, it is now our duty as savers and investors to either be able to put those emotions aside somehow or, in our case, try to take advantage of the majority of people around us who do not recognize this flaw and continue to make the same mistakes. Computers or not, Algos or not, there is a tremendous arbitrage there.
The way I learned it was that the Bond Market is smarter than the Stock Market. I've heard theories that it's because the Bond Traders are smarter than stock jockeys. Maybe it's because the Bond market is a lot bigger than the Stock Market. Maybe it's all a bunch of nonsense. Who knows? The way I like to approach it is simply to use them both to my advantage equally. They both play a role in the process. When we see evidence of risk appetite in the stock market, we want to see the bond market confirming that and vice versa. It's when one is suggesting one thing and the other is signaling something else that we start to question what is really going on here.
Today we're going to focus on 3 specific spreads that we want to be watching closely here as the Summer comes to an end.
Every market environment is different. It's changing every day. What might give us insight into what's happening during one period of time in the market doesn't guarantee that it will help in the future, or ever again for that matter. Back in 2008-2009, correlations spiked all over the world and the US Dollar was moving in the exact opposite direction as the S&P500. Watching the Euro and more specifically the Euro/Yen was a huge advantage back them. I remember it like it was yesterday. But in today's environment, those negative correlations are no longer valid. It's a different market environment now. It's always different.
So while the EUR/JPY and the US Dollar Index were great tells for the direction of US Stocks in 2008, today we're looking at different indicators. Two that I'm particularly focused on right now are Germany and London. First of all, these are 2 of the most important indexes in the world. Top 3? Top 5? Either way, both of them are on the Mount Rushmore of Stock Market Indexes.
Every month I host a conference call for All Star Charts Premium Members where we discuss ongoing themes throughout the global marketplace as well as changes in trends where new positions would be most appropriate. This includes U.S. Stocks & Sectors, International Stock Indexes, Commodities, Currencies and Interest Rate Markets.
We've been bullish towards US and Global Stocks once again since May. I still think this is an environment where we need to be buying weakness in stocks, not selling strength. The weight of the evidence is still pointing to an increased amount of risk appetite, not risk aversion. I ran through all 1000 charts of the S&P500 stocks on both weekly and daily timeframes and there are more good ones than bad ones. A lot more good ones, in fact. It's hard for me to fight that.
It's the middle of the summer and everything is quiet. Even the slightest bit of volatility brings in the panic. It's pretty amazing to watch. There are two schools of thought here. First, the historic short positions in S&P500 Volatility Index Futures have their monthly unwind, and stocks get adjusted accordingly. It's a volatility trade unwinding causing these 1 or 2 day spikes. But then the shorts come back in, make money for a period of time and then get swept out again, like this week. The cycle repeats. Now we move on again and volatility shorts crush it for the rest of the summer. That's thesis 1.
The other scenario is that there is a lot more squeeze behind this one and stocks can have a much bigger and longer adjustment. Take a look at the C.O.T. Reports. The numbers are outrageous. These Volatility shorts are natural buyers of volatility. It's scary when you think about it. But regardless, they stay short. It is what it is. Stocks continue to shake them off. But is this time different?
One of the most classic characteristics of markets that are not trending higher is when momentum is getting oversold. Markets in uptrends don't get oversold. They get overbought! Think about it: How can an overwhelming amount of buyers possibly be a bad thing?
I understand there are some strategies that wait for oversold conditions in their indicators to trigger buying opportunities and other things like that. That's cool. But when I am referring to momentum, I am specifically describing a 14-period RSI. For today's discussion we'll focus more on 14-day RSI for this specific timeframe. If we were having a longer-term conversation, we would be looking at a 14-week RSI on a chart that goes back decades. Currently, the weekly chart is in a bullish range, so that is not in question. Today we're focused on the coming months and quarters.
Maybe this is the top for the S&P500. And maybe the Dolphins win the Super Bowl this year. And Maybe I'll have steak for dinner on Friday.
The best part about this business is that none of us know what's going to happen tomorrow. It doesn't matter what you've accomplished until now. We're all trying to win the same war moving forward. It's pretty cool when you think about it.
