Stock Market Outlook 04.16.2018

Stock Market Outlook 04.16.2018

Our weekly checkup/outlook is meant to give me a macro-view of the market. We tend to mostly ignore political talk and the potential effects on markets. Too much of it is empty prognostication. There are likely some ties, but typically too difficult to correlate market movement to political actions.

Instead, we look at what is happening on a weekly basis, with much attention given to current risk/reward ratios.

TradingView Technical Signals

Most index signals have returned to positive scores, with the exception of BOND.

Financials (VFH) are still somewhat weak, along with China Tech (CQQQ) and the BRIC index BKF.

Notably, VIX has dropped considerably, especially on a weekly basis.

market update trading view signals

Data via TradingView.com (Click here to get 30% off a Pro subscription.)
Scored as follows:
-2 = strong sell
-1 = sell
0 = neutral
1 = buy
2 = strong buy

Gannon’s Risk Insight

Old Prof believes little has changed from last week, with poor short term conditions. Long-term risk has risen over the last 2 weeks.

Short-term trading conditions remained poor this week. In mildly bearish conditions our trading approaches can still be profitable, but that might not be true for everyone. We continue to monitor the technical health measures on a daily basis. If this indicator goes to fullish bearish, we liquidate trading (not investment) positions. We are not quite at that point, but I have rounded the result to “5.” This is not a forecast that the market will decline. It indicates increased difficulty in trading profitably.

The long-term fundamentals and outlook are little changed. Based upon historical data for this indicator, I have increased the 9-month recession probability to the 18% range. I am monitoring, but not yet especially worried. The long-term technical health is 1.5, but I rounded it up.

StockTrader Take

StockTrader says conditions have improved and there’s a need to remain cautious.

Short term: Things look better than a week ago but some more work is needed over the intermediate term. The S&P 500 DID hold that 200 day moving average despite testing it quite a few times. That said breaking over 2800 would be a new “higher high” and would signal and all clear – that is quite a ways away. Also, breaking over the trendline connecting the 2 recent highs of January and March would be a needed first step.

Also of note on earnings season, which is expected to be strong:

Earnings season will begin in earnest with the next few weeks bringing most of the big hitters. Earnings season is expected to very strong – it will be interesting to see how companies guide up the rest of the year due to the tax cuts.

My take is that enterprise software companies will report especially strong earnings, gaining both from direct tax cuts, as well as other companies spending gains from tax cuts on implementing and improving software.

Other articles of notes

Sentiment Now Broadly Bearish:

In prior posts highlighting investor sentiment data it has been noted that sentiment data is more actionable at market bottoms than at market tops.

With much of the sentiment now decidedly bearish, just possibly the market is nearing a bottom.

Update: Predicting the next recession:

[CR April 2018 Update: This was written in 2013 – and my prediction for no “recession for a few years” was correct. This still seems correct today, so no recession in the immediate future (not in 2018). ]

Our Take

Market is volatile yet economy remains strong. Some concern over war but most political talk of late has been of little substance. Tradewars appear overblown, while tax law changes seem undervalued in many companies. Enterprise software companies remain a favorite. If things look week after earnings season, will need to re-evaluate.

 

Market Outlook March 26, 2018

Technical Indicators

Trading View technical indicators point to sell for daily timeframes, with a mix of buy and sell among weekly timeframes among various indexes. Most indexes remain with a buy indicator evaluated on monthly timeframes.

Notably, SPY has a Strong Buy recommendation on the 30-day timeframe. BOND remains to have very negative technical indicators.

VIX has picked up considerably. In this case, buy and strong buy may be considered inversely when looking at outlook for the general market.

-2 = strong sell
-1 = sell
0 = neutral
1 = buy
2 = strong buy

Score gives 3x weight to 30-day indicators and 2x weight to 7-day indicators.

What others are saying

1 . Old Prof remains bullish on the market:

Short-term trading conditions improved again this week. Once again this shows why you need objective indicators rather than relying on your impressions about events. We continue to monitor the technical health measures on a daily basis.

The long-term fundamentals and outlook have been unchanged through the recent bout of volatility.

He also advises to watch the potential trade wars and to remain be weary of negative headlines:

Impressionistic reaction to headlines should not drive your decisions.

2. David Templeton at DisciplinedInvesting writes that the market appears oversold in the short-term and relatively normal long-term:

On a short term basis the indices appear to be oversold. One measure to evaluate is the percentage of stocks trading above their 50 and 200 day moving averages. The first chart shows only 15% of S&P 500 stocks are trading above their 50 day moving average. The chart shows that this measure can get reach the single digits, but mid to low teens is one indication of a short term oversold market.

Conversely, the percentage of stocks trading above their 200 day moving average is 51%. This percentage falls in the lower end of a long term range, with some oversold levels reaching into the mid to upper teens though.In other words, short term, the market appears oversold, but on a longer term basis, not so much.

3. At TraderFeed, Mark Hanna speculates as to the reasons for the recent volatility (trade wars, facebook, etc.), though there’s always a reason to be found to confirm positive or negative movements, and rarely are they correlated. Regardless, the outcome was a bad week:

Whatever the case, the market suffered badly this past week.    Facebook (FB) and it’s scandal hurt the NASDAQ early in the week, then #TRADEWARS(tm)! hurt Thursday and Friday.   The S&P 500 fell 6.0%! and the NASDAQ 6.5%! on the week

He goes on to point out that things still look good on a long-term basis:

Long term: Even after a massive one week selloff, the NASDAQ is only in the middle of a massive uptrend in it’s weekly chart.

Outlook

We are remaining mostly invested in the market. There are many headlines about a potential negative turn, yet there doesn’t seem to be any underlying reason and certainly no evidence of a long-term downward trend. While there is that possibility, it appears the risk is relatively low and there’s a strong chance of a continue bullish trend overall in markets.

 

Cryptocurrency and Bitcoin in Google Trends

Inspired by a post at WooBull on using Google Trends to detect Bitcoin price bubbles, here’s an updated Google trends graph of the terms “BTC USD” and “cryptocurrency”, which we added for comparison sake.

Bitcoin NVT, NVT Signal trending upwards

$BTC NVT is trending upwards after bottoming Feb 6. See chart from @coinmetrics. NVT Signal chart from @Woonomic shows similar pattern. #bitcoin

Bitcoin’s NVT (network value/transaction) has been moving in a general upward trend since bottoming on Feb 6th. Here’s a chart using the great charting tools at coinmetrics.io:

bitcoin nvt moving up

Likewise, Willy Woo’s NVT Signal chart shows a similar pattern:

 

Factors to Consider before Selling

Continuing with our portfolio adjustments today and some more thoughts on portfolio allocation and risk ratios, which are highly dependent on target prices.

A target price is good for weighing risk/reward, but shouldn’t be used for decision making in terms of when to sell. Investments need to be reassessed before any of those decisions can be made.  When we review individual stock investments, we consider a number of different factors.

As trend followers, we begin with reviewing the themes we’re following. If our outlook has changed on a particular trend, we’d look to get out of any positions that play into that trend.

However, we rarely change the trends we follow (we look for long term themes/trends) so that’s not often the case. Assuming the stock fits into our current themes, we look at the individual stock from both a fundamental and technical standpoint. We prefer undervalued businesses, but are more concerned with momentum over the previous 3/6/12 months. It’s tough to go against the crowd for a long period anyway.

Assuming we still like the business, we then assign a new target price and set a new stop loss to get a new risk ratio. These target prices tend to be realistic and optimistic, as we’ve already determined that we believe strongly in the theme and are now looking for the best case scenarios. Regardless of the new risk ratio, no action is taken until reviewing the entire portfolio.

After updating all holdings, we  can then review how each stock plays into the portfolio as a whole. At times, we may see the need to add some risk by exchange particularly low reward positions for stocks with greater upside. By assigning both a target and stop loss price, it’s possible to quickly get a best/worst case scenario for the portfolio as a whole, making these decisions much easier than when looking at a stock in isolation.

 

NOTE: Howard Lindzon’s post about someone asking when to sell $600k worth of Bitcoin inspired my thinking about all the other factors that go into deciding when to sell outside of price. M

Risk Ratio & Asset Allocation

Continuing on our recent theme of structuring and building stock and alternative investment portfolios, I wanted to share a few thoughts on how risk ratios play into asset allocation.

When assessing any opportunity, it’s important to look at the best and worst case scenario, at least taken to a reasonable degree, then compare the potential gains versus the potential losses to get a risk ratio. Defining the downside is relatively easy stocks by setting stop losses set at a reasonable amount below the investment value.

In alternative investments, it’s not quite as easy as setting a stop loss sell price. To start, there’s the problem of valuing alternative assets. Values can only be considered estimates until a sale occurs, as prices often can fluctuate significantly in private asset sales. That leads to the second problem of a limited market of buyers for alternative assets. Alternative assets are decidedly less liquid than stocks, so when considering the worst case scenario, you need to consider the actual value if you needed to liquidate for cash within a reasonable amount of time. That time changes based on cashflow requirements, type of asset, and other variables that can be assessed on a case by case basis.

The upside is a relative guess for both stocks and alternative investments, though assets like real estate are typically much easier to estimate than a single stock or a single angel investment. In all cases, it’s important to come up with a reasonable estimate of the target value, should everything go right.

From there, it’s easy to get a risk ratio by dividing the potential gain by the potential loss. A high risk ratio means there’s more upside and implies the likelihood is decreased. While true, it’s important to account for how much capital is at stake and know how often you need to be right in order to win.

Working through these numbers before making an investment can help visualize how the investment plays into your portfolio, in terms of capital at stake, the worst/best case scenarios.

For our own investments, we set our numbers at the initial time of investment, then reassess occasionally by updating the target price, market/estimated value, low value, etc in a spreadsheet, based on any new information/developments. By using the spreadsheet, we get a chance to quickly reassess each investment and see how our assumptions affect our portfolio as a whole, potentially triggering other changes, including changes to our asset allocation.

NOTES:

Our own spreadsheet is based on Chris Perruna’s spreadsheets, which he included in a post on Position Sizing & Expectancy. Give that a read for more info.

We’re working on updating our portfolio tracking spreadsheet to work with a combination of stocks, crypto, and alternative investments. We’ll share a template when complete.

Thoughts on Market Timing & Crashes

There’s been a lot of talk of markets being very expensive lately. This includes US stock markets, crypto, international stocks, venture capital, and many other markets. With everything being expensive, many have come to the natural inclination that a downturn must be imminent. The thought has certainly crossed my mind recently while working on our theme-based stock portfolio.

At some point, there will be a correction to all of these expensive markets. There’s no doubt about that. The problem comes in trying to guess when that may be, how far up it still has to go, and how far down it may tumble. Without knowing those three, there’s really no way to gauge when to enter or exit an investment. Of course, it’s not exactly easy to guess.

Some extremely successful investment managers like Jeremy Grantham and Howard Marks seem to think the markets are extremely risky, and have changed their portfolios accordingly. Many others, including Buffett, believe it’s foolish to try to time general market cycles, citing the risk in giving up potential huge gains while awaiting the impending crash.

We lean more towards the second line of thought, believing that the right investment can withstand negative shocks, at least to a better extent than the market as a whole, and that trying to guess what the market as a whole will do is a futile exercise. This thought process applies to our investments in public markets, as well as our private alternative investments.

Relating to the stock market, the style of ignoring market conditions works best when selecting individual companies rather than widespread market index funds. The more finite the selection (industry etf, specific stock), the greater the potential for either superior or inferior performance compared to the market as a whole, in the event of a widespread downturn.

As we work to build our theme-based portfolio, we are specifically looking for companies we believe provide room for significant upside while having a perceived lower downside compared to the market as a whole.

 

HELPFUL READING

10 things investors can expect in 2018 – Ben Carlson
When things don’t make any sense – Ben Carlson
Stock Trends for 2018 – Chris Perruna
Bracing Yourself for a Possible Near-Term Melt-Up  – Jeremy Grantham
How to Survive a Melt Up – Ben Carlson

 

Building a Stock Market Portfolio by Theme

Even with alternative investing in mind, many investors, including ourselves, keep some amount of capital in public market investments. There’s potential for considerable upside, though typically less than alternative investments. There’s no control of the investment, both in the sense that you can’t control the company’s performance nor how the market reacts, which may or not be in line with the company’s performance.  Though the higher liquidity is nice both as a piece of mind and potential to get out of bad investments quickly.

There’s a number of ways to go about constructing a portfolio. From a basic perspective that including roboadvisors, human advisors, handpicking index funds, and handpicking individual stocks. Of course, it’s also possible to use some combination of these styles.

Personally, I’m not a big fan of losing control of where my money goes, such as the case with index funds. There are a number of companies with which I’d prefer not to be associated with, either for business or personal reasons, so I’d rather handpick individual companies, much like I do with individual alternative investments. In some cases, this isn’t feasible due to a lack of knowledge of individual businesses or difficulty in investing in specific businesses.

Actively selecting individual securities is a mostly outdated style, though the tools and info make it easier than ever to be informed and to act (buy/sell). For us, it’s about investing in good companies in trending areas ripe for growth. The themes were following for 2018 include:

  • fintech – technology is completely changing finance. this includes roboadvisors but is much more than that including payments, funding, etc.
  • crypto – it may be a bubble yet that could still grow significantly before it pops. regardless, there’s new technology and it will have major implications. many existing public companies are already involved.
  • marijuana – things may be volatile in the U.S. under Trump/Sessions. Still seems inevitable at some point in future that this will be federally legal. For now, Canada offers some options as it’s scheduled to be federally legal there in july.
  • ecommerce – this has grown every quarter for over 13 years as a percentage of total retail sales. amazon is the leader, still growing but largely outside of retail. more and more business is done online.
  • automation – things are getting automated, jobs are changing. it’s inevitable. companies that take advantage of this will will.
  • cyber security – more attacks likely in the coming years. security becoming a bigger concern to companies. more resources being allocated to security.
  • technology – there’s a general pro-technology consumer market that wants the next device constantly. this may not always be the case but for now people willing to give significant resources (time, money) to technology. recently, there’s been some pullback in terms of news stories, but usage and spending hasn’t diminished at all.
  • non-meat foods – includes organic produce, healthy grains, and meat-replacement solutions
  • pro-women – companies that are very pro-women will benefit from both publicizing their message and making their organization very fair and open
  • china – huge and growing middle class market.

The next step is to find companies working in these themes. They may not be 100% focused, but should a leader in that area, giving them room for substantial growth as the market grows. We’ll look more at individual selections in a later post.

 

Alternative Investment Options

Alternative investing, meant to include anything not traded on the traditional finance exchanges, are enticing to small investors because of the potential for more control and greater upside. This typically comes in exchange for more volatility and/or less liquidity. Essentially, there’s a cost for investing in public markets due to the ease of access and liquidity and alternative investments should seek the investments that may be a little harder to reach and get greater returns.

With that in mind, here’s a few ideas on alternative investment options:

  • Real estate. The biggest alternative investment market. Many different ways to invest from very hands, fix and flip, to passive investments in real estate projects. Lots of potential to use leverage. Many online tools have become available to help investors find projects. Returns often not as good as what can be found by networking for deals.
  • Crypto. New market that went from ~$15 billion to $500 billion in 2017. Lots of potential to invest still. Bitcoin and ethereum have potential. More exciting is new technology will result in some big winners. Finding the best tokens is very difficult. Very risky overall.
  • Forex. Never interested me much as it seems there is always somewhat limited upside. Seems not meant for passive investing but active trading.
  • Peer-to-peer lending. Appears quite risky but have not looked into it much.
  • Angel investing. Many online tools for investing in new businesses. Very limited liquidity. Potential for big gains. Very volatile.
  • Buying businesses. Not necessarily passive, amount can be determined by owner. With right criteria, risks can be mitigated. Some potential for leveraging money. Can result in cashflow or flip for a big payoff.

We’ve already invested in some of these and we’ll look at some of these options in more detail with new posts over the coming weeks and months.