The Trend Is Your Friend

Fri, Mar 14, 2014 - 8:28am

Big Picture — Monetary policy remains accommodative and housing is rebounding in the developed world. Consequently, business activity is improving and this is being reflected in the related stock markets.

You will recall that approximately 2 years ago, we observed that the housing markets of Europe and the US were bottoming out and at that time, we stated that a boom in this sector would be a major positive catalyst for the developed world. Back then, most market participants were pessimistic, but raw data was indicating some improvement in housing.

As it turns out, our assessment was correct and over the past 2 years, property prices have risen and the construction industry has assisted in bringing down the elevated unemployment rates in the developed world.

Going forward, we suspect that as long as monetary policy remains accommodative, housing markets will continue to heal and this will be good for the developed world. At some point in the future, credit growth will accelerate, prices will rise sharply and central banks will start tightening monetary policy. When that happens, credit creation will diminish, business activity will slow down and we will get the next recession (bear market in common stocks).

[Hear More: David Rosenberg: Greatest Risk to Investors Is Now Inflation; Major Shock Needed to Derail Economy, Bull Market]

Although we do not possess a crystal ball and cannot guarantee when central banks will start raising interest rates; we suspect that the yield curve will not invert for at least another 2-3 years; thus the ongoing uptrend in stocks may continue until 2016-2017.

In any event, there is no need for us to jump the gun and for now, the S&P 500 Index remains in a firm uptrend (Figure 1); thus, our readers should continue to ride the wave. Remember, in the investment business, the trend is your friend and you never go broke going with the flow. Thus, as long as the path of least resistance remains up, investors should maintain their holdings in the strongest sectors.

Figure 1: S&P500 Index (monthly chart)


Before we go on to discuss the strong sectors, we want to reiterate the fact that this bull market is tricky, in the sense that not all sectors are participating in the advance. In fact, approximately 50% of the stocks traded on the NYSE have already topped out and they are now breaking down. Make no mistake, this type of divergence is usually only seen in the latter stages of a bull market, so we are inclined to believe that we are now dealing with a mature uptrend.

[See Also: While Markets Make Records, Selectivity Is Becoming an Issue]

Bearing in mind the above, it is extremely important that our readers stay aligned with the leading stocks in the strongest industry groups. As you can see from Figure 2, over the past 200 days, healthcare (which includes biotechnology) has been the strongest performer and industrials, cyclicals, technology, and materials have all generated positive returns. Conversely, consumer staples, energy, and utilities have performed poorly and unless the trend changes, these sectors should be avoided.

Figure 2: Various Sectors – Relative Performance


Amongst the sub-sectors, it is noteworthy that the homebuilders and other housing related stocks are now breaking out of large bases and they should be purchased. Elsewhere, a number of commodities, precious metals and shipping stocks are also breaking out of large consolidation patterns and they could advance sharply. Therefore, our readers may want to consider investing fresh capital in these areas.

At this stage of the game, we do not know whether the shipping industry has seen its worst but many related stocks are breaking out and it seems as though this cyclical sector is in the early stages of a lengthy recovery. Furthermore, bearing in mind the fact that the shipping stocks are significantly depressed, there is a real possibility of outsized gains.

Looking at geographical exposure, it is notable that the stock markets of the developed world are leading the way and in addition to Wall Street, many European indices have also climbed to multi-year highs. Within Europe, it is interesting to observe that Greece’s stock market has bottomed out (Figure 3) and as a speculation, some capital can be allocated to this bombed out nation.

Figure 3: Greece (Athens) General Share Index


Over in Asia, many prominent indices are underperforming and even Japan has recently experienced a severe pullback. If you review weekly charts, you will note that the majority of the Asian markets (Hong Kong, India, South Korea, Singapore and Taiwan) are caught in a trading range and none of them are at new highs. Elsewhere, the previously high-flying stock markets of the Philippines and Thailand are now undergoing significant corrections and it is difficult to tell when the pullbacks will end.

As far as China is concerned, the Shanghai Composite Index has been a disaster for several years and we continue to believe that the looming property bust is weighing on its stock market. At present, the Shanghai Composite Index is in a firmly established downtrend and it is currently trading under the 200-day moving average. Therefore, this is not the time to be invested in the world’s second largest economy.

[You May Also Like: Chinese Property Bubble May Collapse in a Year or Two]

Last but not least, after a sizable pullback, it appears as though Japan’s stock market is setting itself up for another advance; so this is the time to have some exposure to the Tokyo Nikkei Average.

In summary, although the ongoing bull market on Wall Street is now mature, we suspect that the festivities may continue for several years. Furthermore, we suspect that Wall Street’s positive influence will continue to assist the stocks markets of Europe and Japan; thus our readers should overweight their investment portfolios to the developed world.

Precious Metals – After almost 3 years, gold bugs can rejoice!

As Figure 4 shows, after completing a ‘double bottom’ formation around the US,180 per ounce area, the price of gold has finally climbed above the key moving averages. Furthermore, after a brief consolidation, the price of the yellow metal has climbed to a new rally high and it appears as though the advance will continue.

[Related: Ned Schmidt: Bear Market in Gold Is Over]

From a technical perspective, a close above US,362 per ounce will be constructive and clearance of the US,424 per ounce level will set the stage for a much larger rally. Accordingly, our readers may want to get onboard this moving train and enjoy the northbound journey.

Figure 4: Gold – Regaining Its Shine?


In addition to gold, the price of silver has also cleared the 200-day moving average and if the ongoing rally is the ‘real deal’, then the white metal should also appreciate in value. Thus, aggressive traders and risk takers can consider buying some silver, but they must remember that silver is an extremely volatile animal. Accordingly, it is best not to get too exposed to this metal.

As far as the mining stocks are concerned, it is encouraging to note that the AMEX Gold Bugs Index is acting well and participating in the ongoing rally. More importantly, this index has climbed above the key moving averages and it is probable that the uptrend will remain intact for a while. Therefore, this is a good time to allocate some capital to the gold and silver mining stocks.

At this stage of the game, nobody knows why precious metals are advancing. However, the reason is largely irrelevant and what is important is the fact that after almost 3 years, we now have a relatively new uptrend.

About the Author