With the S&P 500 trending higher and overbought, I hear the word “extended” used a lot. Just tack that onto some of the other bearish comments that have been made about this rally since October (see table). Another recent one that has been rising is gasoline prices. As a chartist and technician, I’m more interested in what the market is saying than the bears or the bulls. I think if you stretch out with your feelings, as Ben Obi-Wan Kenobi once said to Luke and stretch out your charts, the charts look a lot less “extended” than originally thought. So let’s stretch out those charts and gain some perspective here.
Chart courtesy of Wolfe Trahan
Stretching the Charts
One simple mistake many amateur chartists make, is sticking to daily charts. The problem with viewing daily charts is they tend to only show a data range of maybe 9 months of data, or less. When viewing the price range of a company that has been around for more than 10 years, stretch out the chart by extending the range to more than one year and look at a weekly and monthly chart. Monthly charts are typically across a span of 10 years or more. It’s important to stretch out the charts because there is a lot more “significance” paid when inflection points are made in the long-term monthly and weekly charts rather than the daily. Long term technical changes are made slowly and have lasting effects. I think Dennis Gartman said it best yesterday on CNBC when he highlighted the reversal in gold yesterday.
"When I see daily reversals, a new high and taking out the previous day’s low, I pay attention. When I see weekly reversals, I really pay attention. When you see a monthly reversal, if you don’t pay attention, you’re an idiot,” he said. “I think you have to be pay attention. I think there’s probably going to be more liquidation.” Dennis Gartman, Fast Money 2/28/2012
For example, let’s look at a daily chart of EMC Corp. The stock is up 40% from the October 4th low. The RSI has stubbornly stayed in overbought territory above 70 since late January. This is the perfect picture of “extended”, on the daily chart.
However, if we turn to a monthly chart and view how much this company was worth in the tech bull market, the chart paints an entirely different picture. It shows the chart of a company that has been basing for ten years, and is beginning to breakout. EMC is now trading above the last bull market cycle high in 2007. That’s a serious inflection point. Does EMC look extended now? I don’t think so.
EMC isn’t alone. The NASDAQ Composite has broken out above the 2007 high, currently at 2985, and many large-cap tech stocks have made similar base breakouts like EMC. Many critics could say, well that’s because Apple is driving the market higher, currently 16% of the weighting in the NASDAQ 100 Composite. That is the case, but there are also many other fundamental reasons why. Cloud computing is changing the technological landscape just like the internet did in the 90s. Additionally, smart phones and tablet PCs are changing the ways at which we both demand information and access it. These are long-term drivers to growth in the technology, software, and telecommunications industries.
As Jim Puplava has said on the radio show recently, “You liked Intel at 60 times earnings in 2000. You wouldn’t own it now at 10.79 times earnings?" In the eleven years since that price multiple crashed and the stock has been basing, revenues have grown 60 percent and earnings have grown 57%. Maybe it’s time to stretch out with your feelings on technology again? Many I talk to still carry around baggage from ten years ago by money lost in the aftermath of the tech bubble. When is it time to let that go? As Mace Windu said to Anakin Skywalker, “I sense a great deal of confusion in you, young Skywalker. There is much fear that clouds your judgment.” Don’t let the tech bubble cloud your judgment! Not only have tech stocks been performing quite well over recent years but many tech giants have also awoken from their 10-year slumbers. Going back even further, Jim Puplava remembers when nobody wanted to own stocks after the crash of 1987. That was exactly the best time to buy. Don’t let fear cloud your judgment.
Stretching Your Extended Outlook
So why is the extended subject important today? From a technical stand point, the market is overbought and the word “extended” isn’t that far off base; however, trends can stay overbought and extended for a while. The S&P 500 and many stocks that have rallied 10-25% or more over the past five months look “extended” and you’re waiting for a pullback before you “get on board” with this rally. You may even doubt this rally completely, buying bonds (as the fund flow data show) and you don’t even plan to buy a single stock. Your allocation to equities is obviously an individual decision based on your personal suitability, but here are some reasons why I own them for growth clients.
1. Window of Opportunity
As Chris Puplava wrote in October 2011, we have a "Window of Opportunity" despite the ECRI’s recession call with better manufacturing and cheaper commodities. Recall the manufacturing and car component supply problem stemming from Japan’s tsunami? That pent-up demand began working itself off in the second half of 2011 when the leading economic indicators turned up in the manufacturing and non-manufacturing ISMs and Purchasing Manager Index (PMI) data. Additionally, the price of oil and other commodities dropped mid-2011 creating a stimulus for consumer spending.
2. Good Breadth
79.5 percent of the S&P 500 stocks are trading above their 200-day moving average. This is a very positive sign that the recovery from October wasn’t just for Apple shareholders. The majority of the stock market shows improving chart patterns.
3. Central Bank Accommodation
We live in a 0% interest rate environment. Investors are being pushed out on the risk curve to find returns. We had a number of accommodative moves by central banks made just last month from the PBOC, BOE, ECB, and the Fed.
4. Better Jobs Data and Consumer Confidence
With better jobs data and better consumer confidence, we should be able to weather higher oil prices. In addition to central bank accommodation, economic data has been very supportive of this rally.
5. Natural Gas Offsetting Rise In Oil
Natural gas has fallen 50% since last summer from mmbtu to .45 mmbtu currently. Power generation can switch to the cheaper fuel. Warmer weather and higher production trends support this for some time. Oil is in everything and it will definitely be felt in the pocket book if gas prices rise to a gallon this summer, but the idea here is that the economy can better withstand higher prices now.
6. Climbing the Wall of Worry
I recently read Marc Faber’s March commentary today. He cited some statistical data from Goldman Sachs saying, “The typical hedge fund generated a 2012 year-to-date return of 3% through February 10th, compared with 7% gains for both the S&P 500 and the average large-cap core mutual fund. 50% of hedge funds have generated returns between -2% and 2% and only 10% have returned more than 7%, outperforming the S&P 500.”
Conclusion
The market is vulnerable to a correction because we’ve trended straight up, but it’s clear to me in my research that a correction would likely be shallow and constructive. While we have seen some recent divergences in the Russell 2000 as well as the Dow Jones Transports—they’ve consolidated while the market has headed higher—I would have to say neither have “broken down” nor have they shown any real technical damage. There are actually hints that both are improving which could further empower the stock rally from here.
The Transport index is rallying strongly off of the 50-day moving average today. The Russell 2000, with all of its 21.85% weighting in financials, has merely consolidated sideways to work off its overbought readings in January. The Russell 2000 was the strongest index today in the morning before correcting somewhat, up 1.37% to close up 0.52% due to the financial sector’s strength; however, that index will continue to remain in a consolidation mode until it breaks above 833.
Many of the financials are registering breakouts today from basing patterns. The market could whipsaw, but I doubt it. I think the market’s technical health continues to improve. Even the slap on the face to commodities yesterday by Bernanke looks like a blip on the radar now. The CRB index tested its base breakout yesterday and held with a rally off the intraday lows. The CRB index looks very constructive despite the selloff in gold yesterday. Don’t be a commodity bear just because you didn’t get your QE 3 honey in Bernanke’s speech. There’s plenty of central bank accommodation out there, and the lag in market effect is substantial – typically 6 months. Like my article last week stated, commodities are at an inflection point, even without QE3.
I can’t do all of your homework, but suffice it to say, there are many stocks with basing patterns like EMC over the past few years that are just now breaking out. Sift through the charts, find them, and then research the companies to find the catalysts. If catalysts are there, buy them on breakouts or retests of support. If you don’t have the time, PFS Group does. We’ve been managing money based on the business cycle and the macro outlook since 1985. Some people prefer golf, sailing, and traveling; or they work for a living outside of the financial industry. Not everybody has the 10 hours a day we spend analyzing the charts, news, and research. If you can’t remove your fear from clouding your judgment like Anakin Skywalker, maybe the right investment advisor can.
