Monthly Breakout Watchlist (October)

The long-term charts of the major indices remain in consolidation patterns within larger uptrends. I realize there is a ton a angst due to the pending presidential election, Fed interest rate policy, short-term trends, etc. however zooming out the timeframe a bit clears up all of the noise and shows us a market that remains in a bullish trending posture. Many are worried about the Russell 2000 (small caps) here yet one look at the monthly chart shows the first down month after 8 vertical months of uptrend. A pause and some rotation there would not be a major concern, it would actually be pretty normal considering the recent rally it has had since February.

Yes breadth has weakened over the past two months, but rotation remains in place as offensive sectors continue to be the focus of new funds coming into stocks. This month's list of new base breakouts is top heavy Financials, Regional Banks in particular look very strong at the current time.

I always take my cue from the stocks themselves rather than opinions, indicators, macro fears, etc. If stocks are making new highs and breaking higher from bases I have places to deploy fresh capital. Should those breakouts fail we will be stopped out for modest losses and will await the next signals.

ODFL

RJF

YDKN

CBF

FRME

AWH

FFIV

EXPE 

If you missed my early post this week regarding Relative Value and how I use longer-term trends to find opportunities give it a look here. All of the above setups are now igniting from that basic strategy and could become large winners over the next several months to year +.

Thanks for reading
-ZT

Relative Value and the 20 Month Moving Average

Looking at monthly charts can present great opportunities missed by many who become too focused on the short-term action. How I determine relative value in the market is by watching how trends consolidate near and around the 20 Month Simple Moving Average. I find it remarkable how many stocks tend to "cool off" over a period of time but then ignite very soon after reaching this notable trend average.

I use these consolidations to add exposure to current positions and to get a sense of where some hidden value may be found in an uptrend.

Good things tend to happen when prices near these levels. Either the response is rapidly positive or the stock will alert you to more trouble ahead. The risk/reward therefore sits firmly in our favor by heeding this pattern.

Check out some of the opportunities we have been involved in this past year due to this particular pattern:

NFLX

UNH

ABMD

AMZN

FB

TSN

RAI

Similarly this pattern can act as a strong indication that trouble may be lurking ahead:

TWTR

GILD

WFC

Here are a few to watch currently that are setting up as we speak:

HD

MCD

AEP

TXRH

CHK

These are long-term patterns and don't automatically suggest a buy or sell, but when prices approach this area I become very interested. Pullbacks of this nature (or rallies in downtrends) tend to catch most short-term investors quite off-sides to the more dominant trend in place. We tend to get sucked into the day-to-day action but the big moves start here, on the long-term charts. The reason these setups tend to work and be explosive is exactly because enough time has elapsed to dull the senses of short-term participants. While they are ignoring the "messy" setup based on the Daily timeframe, the long-term momentum is about to ignite providing strong value for those paying attention.

The Home Depot example above really drives this theory home. I recall back in mid-2014 when the return of HD over the past 12+ months had been literally zero. Traders had no interest at all in the name and I was becoming very very interested. At the time the stock was trading between $75-80 per share. It wasn't until mid summer that the trend ignited higher; over the next 7 months HD went from $80 to nearly $120 in a straight line. I then recall the sentiment surrounding the stock at the beginning of 2015, everyone was bullish and just dying to throw money at it.

The above example is not an anomaly, most market participants have a very short attention span and don't have the patience to try to see the bigger picture. They have a tendency to chase the flavor of the week and ignore where the relative value is hiding, gearing up for the next advance.

Again these patterns don't always work but they tend to skew the odds in our favor over the long-term. I have seen enough examples over the years to know this pattern pays much more than it loses. When prices approach the long-term trend average good things tend to happen and it is wise to pay attention.

Thanks for reading
-ZT

Breadth Pivot Point

While the SP500 continues to trade in a volatile manner often identifying the current "trend" can be difficult. One way we can determine the overall health of the market is to watch how stocks are moving under the surface. Following the breadth of the market can be a helpful tool for trying to figure out the undercurrent of the larger trend and if/when it may be at a turning point.

I track the top 90 stocks in the SP500 as the "leaders", these tend to be the largest and strongest stocks in the world. The list I track is the from the 9 major Sector SPDR ETFs (XLF, XLY, XLK, XLI, XLE, XLB, XLP, XLV, XLU). Each group is composed of 10 top holdings. These represent the best of breed stocks in their respective industries, think J.P. Morgan, Apple, Google, Amazon, Honeywell, United Healthcare, Chevron, Bristol Meyers, etc.

I find it helpful to track these market leaders on a weekly basis to determine the overall health of the market. These stocks will begin to move ahead of the broad market averages and often hint to the next market trend. This process is not perfect but it allows us to draw a picture of the undercurrent moving the waves on the surface.

This number is tracked on a weekly basis using the price relative to the rising or declining 20 Week Moving Average. As you can imagine the stronger the trend the higher the number and vice versa. Although I will note that even in the strongest trending markets such as 2013 the highest reading from this indicator was 80. This means 80 out of the 90 stocks were trading above their rising 20 Week SMA's. The opposite is also true, when the trend is weak and stocks are breaking down.

Similar to an RSI indicator I've found that depending on the larger market type (bull market trend for example) that these breadth readings tend to trade within a range between 70+ to 30. When the trend turns negative the range shifts to 40 as resistance and 8 has been the lowest reading recorded. Which brings us to our current structure.

This week's reading came in at 30, which has proven to be support in an uptrending environment. But it also tends to be the pivot point for a healthy bull market and where conditions change dramatically into a downtrending environment. Currently we sit at an important level. Since 2013 there have been eight such readings of 30 stocks trading above the rising 20 Week SMA.

SP500 showing prior instances of 30/90 Breadth Readings 

The up arrows show where breadth hit 30 and then improved, the down arrows show where the readings were 30 then moved lower.

As you can see this tends to be a very pivotal reading. For the most part it has coincided with substantial swing points in our recent market. If I had to attach my bias on the current setup I would favor a "pullback in an uptrend" rather than an extended rollover. Of course anyone who follows me knows I've been very bullish since early spring and continue to be. Although I do note the recent deterioration in many of my longer-term holdings and am accepting to the possibility that the market can roll to the downside from here.

Something I like about this 30 breadth reading vs prior "peaks" in the price action is that the overall structure of the breadth trend is more similar to the 2014 pullbacks rather than the 2015 peaks. This 30 reading has occurred following an "overbought" 70+ breadth reading (similar to the 2014 instances) vs the 2015 readings which occurred once the breadth trend had deteriorated and never moved above the 50 level. The 2015 readings were also showing negative divergences between the SP500 price trend and the 90 Sector Stocks breadth trend.

Our current structure shows a breadth trend that reached Overbought first on June 17th 2016 and then again for three consecutive weeks from July 15th through July 29th. The current move back to 30 in breadth appears to be an overbought consolidation rather than a dying trend.

One more feather in the cap for the breath readings supporting higher prices is of the 30 stocks maintaining trend the bulk of those stocks are coming out of the Financials, Discretionary, Technology, and Energy sectors. What trends do remain are offensive in nature and suggest a rotation to more economically sensitive groups. The stocks trading in the "downtrending" group are all 10 Utility names, all Consumer Staples stocks (minus PEP), as well as MCD, WMT, KO, T, PM, MO; all stocks that are associated with high dividends and tend to be defensive in nature.

As always we need to keep an open mind, follow the signals that are presented to us (in either direction), and let the market show us the way. If we roll over from here and crash (which it seems most expect and want) then we will get stopped out of our Long positions well before the real damage is done. If we rally from here breadth readings will begin to improve soon and the uptrend will continue with the offensive groups leading the way.

Thanks for reading
-ZT

Risk Rotation

Markets didn't do squat this week on the surface, under the surface however told a different story. Friday's in-line Jobs report wasn't enough to discourage interest rate hawks as TLT hardly budged following a nearly -3% loss earlier in the week. While the action in the SP500 has been choppy and unproductive, stocks have begun a rotation that appears to favor more risk appetite going forward.

What's the one thing that would surprise people the most? I think its a strong rally into the election and right on through. Nearly every person I talk to thinks the election will cause volatility, a big selloff, panic, etc. Those same people also think the market sits on the precipice of mortal disaster (and have thought that for years now).

The Friday release of the Non-Farm Payrolls for September showed the 79th consecutive month of US job growth. That means more people where hired in each of the last 79 months. I have heard it said that the market and job creation follow a very parallel path. Yet certain politicians tell us the US has never been in worse shape, well that's just simply not true. Things happened to be MUCH worse in 2008 than they are today. That's just a fact.

I determine relative strength/weakness by tracking the top 90 stocks in the SP500. Those top stocks showed a strong rotation this past week and have hinted this way for the last couple months. The typical defensive sectors (Utilities, Staples, REITs, Bonds, Metals) all got bludgeoned this week, while offensive groups (Financials, Technology, Energy, Discretionary) showed notable improvement in their underlying and relative trends.

So while the market churns above its prior all-time highs the correct stocks are seeing flows while it appears the over-crowded yield plays are rolling over. Now I am not of the opinion that dividend paying stocks will no longer have value, I still believe in lower interest rates for longer, but the absolute hoard of capital that has been hiding out in safety appears to be finding its way into higher risk/reward groups.

Can you spot the differences? (all charts Weekly)

Offense

Defense

Offense

Defense

Offense

Defense

As is the case with Relative Strength and Trend trading we want to be positioned toward the groups that are pointing up for our timeframe and avoid the groups pointing down.

Its certainly possible that these recent moves are just reverting to their longer-term averages and will be bargains again soon. But for now there are confirmed lower highs for Utilities, Bonds, Gold and I am seeing confirmed higher lows for Energy, Technology, and Financials.

Discretionary vs Staples

The Relative Performance of the Consumer Cyclical (Discretionary) vs the Consumer Staple stocks often suggests the risk appetite of investors in the market and general health of the economy. When consumers are spending more on discretionary items such as home improvement, vacations, toys, restaurants, etc it suggests the economy is healthy as people have extra money to spend, and this ratio rises. If by contrast people are simply getting the essentials like toilet paper, toothbrushes, and cleaning products instead of booking trips to Hawaii or buying new tvs on Amazon, this ratio will fall.

 As of last week we are seeing the first relative uptrend emerging for the higher risk Discretionary sector relative to its more defensive counterpart since late 2015.

I know it almost "seems" too easy, but had you simply taken these signals and the previous two going back to the inception of the XLY and XLP funds, you would have outperformed the SP500 by more than 250%. Just buying the SP500 when this ratio breaks a downtrend and raising cash once the uptrend invalidates would have crushed the return of buy/hold since 2002.

If we are putting money to work we want to look for setups coming out of the relatively strong sectors at the right cycle points for the market as a whole. It appears we have a new cycle buy signal in our ratio above.

 At the close of September (9/30/16) the XLY:XLP ratio has moved above its relative downtrend and is pointing higher. If the past 15-years has been any guide this is not a signal to ignore. With the SP500 still holding above its prior highs and pulling back orderly to retest the July breakout, it appears the path of least resistance is higher.

Yes I know there is the biggest presidential election of our lifetime looming, yes I know US debt is "too unsustainable", and yes I know the Federal Reserve is suppose to raise interest rates like yesterday. The fact remains stocks and sectors under the surface are showing rotation that is indicative of more upside to come.

I mean the Nasdaq is at ALL-TIME HIGHS, yes even above the dot.com bubble peak.

This is not bearish. Above this line there is zero justification to being Short or in cash. Its bombs-away as far as I'm concerned.

Don't hate me, I'm just the messenger.

Thanks for reading
-ZT

Lg-Cap Portfolio Review (September)

US markets made it through statistically the worst performing month of the year, relatively unscathed. The SP500 closed modestly lower losing -0.12%, while the "higher risk" Nasdaq finished September at the highest monthly close ever adding +1.89%.

Its generally a good sign to see the higher beta and more "risk-on" Technology names leading the market higher. It suggests managers feel the economy is on firm footing and more sensitive companies are showing solid growth potential.

When markets struggle and traders are worried about approaching recessions they tend to seek safety assets like Utilities and Staple stocks. Often Technology and Industrial groups struggle as they are more sensitive to economic changes. Currently we are seeing the exact opposite as our markets sit at all-time highs. Tech is leading and safety stocks are being steadily sold as investors position for stronger growth.

Nasdaq Composite Monthly

Not only was September a new monthly closing high, but the price range of September completely engulfed the prior month's bar. The month began by heading to lower lows suggesting a larger consolidation was needed, only to then reverse and close above the prior month's high. A move like this tends to show how sentiment can be effected within the price action. Lower lows make traders position bearish only to then see the exact opposite reaction occur leaving them missing out on a new potential breakout.

The whip of investor sentiment is what powers new trends higher. The trend grows on skepticism, but as the move progresses more and more sidelined traders begin to move back in. This is the fuel that drives the market, if you can identify these shifts it will improve your read of the market significantly.

I believe we are in one of those times now. Both on a shorter-term basis and longer-term. It appears investor expectations vs the actual price movement are not in agreement. Most people you speak with are worried about the election or the Fed or slow growth. Not too many people are saying US markets could rally 50% in the next few years. Sentiment is generally poor and price action is generally strong. That is often a winning combination for savvy market participants and is the framework for how I am approaching the market here.

We had two changes to our Lg-Cap Portfolio in September. We lost LOW and added PCLN. Our Portfolio is once again maxed out; we hold 20 Long positions and one Short position: CMCSA, COST, GOOGL, JPM, MDT, BRKB, PCG, PEP, AEP, CSCO, VZ, CVX, PM, FB, UNH, GE, SHW, PCLN, EOG, MSFT, GILD Puts.

-Exit LOW

LOW moved back below its prior highs and closed below the 20 Month SMA for the first time since 2011. Its possible the trend remains higher but for now I'd rather let someone else figure out if its going to turn on a dime. We take our small loss and step aside.

For a more bullish posture I would want to see price reverse soon and finish a month back above both the 20 SMA and 77.08 (This month's high). On a turnaround here we may give it another look.

+Enter PCLN

While last month's signal was valid I preferred to let this show me a little more. For September PCLN closed at new monthly highs and appears to be emerging from a multi-year base. This is a pretty easy Long for me here. We will put our stops back below the breakout and rising 20 Month SMA.

CMCSA

Digesting the recent rally in an orderly manner.

COST

Costco came in and gave our stop a little poke. What was nearly an exit signal turned on a dime on the last day of trading for September. An item to note is COST hasn't closed a month below its 20 SMA since 2009, and it held once again here. 

So far we still have a shakeout attempt of the bull flag breakout from June. Support held where it should, now lets see if it can get going again or we will be exiting sooner rather than later.

GOOGL

Just hanging out at all-time highs.

JPM

MDT

Stops remain wide for now. A slightly deeper pullback would give us a new swing point to trail to. MDT is very strong.

BRKB

The breakout is being tested quickly here. BRKB also posted an "inside month", so a break either above or below September's range will likely be significant. For now are stops remain below.

PCG

AEP

The Utility rally had gotten a little ahead of itself and is now coming back to earth. This is still an uptrend, they still pay a large dividend, and our previous swing lows have not been tested. We are giving it plenty of room as the long-term action remains constructive. Again, know your timeframe.

PEP

PEP is killing KO on a relative basis.

CSCO

CSCO currently sits at new recovery highs.

VZ

VZ is still moving against our position but it continues to look positive long-term. This action is still a bull flag above a rising 20 SMA. No worries yet

CVX

CVX is building a bullish flag formation as the 20 SMA begins to cup the price action. As long as we are above the prior breakout I want to remain long.

PM

Our stops are still very much out of the way because remember why we are here in the first place. Short-term the action is very sloppy and fairly negative. But slide that chart out and PM has recently made new all-time highs and is consolidating the long-term breakout in an orderly way.

FB

This is giving us no reason to sell, so we don't. Easy trend to ride in this one.

UNH

Bull flag.

GE

GE is finally coming back to test support again. I would expect buyers to return in here soon.

SHW

SHW closed modestly below the prior swing low but also managed to recover and hold its 20 Month SMA. I am bending my rules a tiny bit here as the action still resembles a positive price structure. The stock is retesting the breakout area and its rising MA. I'm willing to give Sherwin the benefit of the doubt for one more month.

EOG

EOG powered higher this month and looks to be in a strong position.

MSFT

Short GILD

Our lone short position continues to trade in a downtrend. It should be noted that Biotech in general has been recovering and yet GILD is having a very hard time getting off its lows. Below the swing high at 82.10 we will stick with it.