The Market Provides Clues…

Dear Reader,

COVID cases around the world have been rising at alarming rates for a while now. Cases have picked up sharply in the US in particular.

For some reason, the market didn’t care. There was enough liquidity to absorb the fears of anyone who thought this was a concern, without knocking stock prices lower.

But for some reason, today the market did care.

The Dow fell 2.7%, the S&P 500 2.6%, while even the NASDAQ declined. It was down 2.2%.

Oil tanked 5.5%, as fears of new lockdowns hurt prospects for a demand-led recovery.

Why investors choose today to worry about something they knew yesterday is beyond the scope of this essay.

Maybe they slept on it.

Maybe just a few more people realised the risk/reward trade-off here is insanely skewed to risk and no reward. As a result, there just wasn’t enough liquidity to absorb those fears without knocking prices lower.

Where to from here though? Is this just another momentary setback in the rise of the fastest (fed-induced) stock market bubble in history?


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The market does provide clues…

But the market does provide clues. Sometimes those clues are duds, and sometimes they are very prescient.

Let me show you one. We’ll soon see if it’s a dud signal or not.

Yesterday, I tweeted a few charts of the NASDAQ. (You can follow me @gcanavan2 if you’re on Twitter.)

I keep a close eye on the NASDAQ as it’s led this long bull market and is the chief absorber of all the liquidity the Fed is throwing at the market.

The first chart, I said, looked bullish. It was a short-term view of the index, showing prices breaking out above the February high to new all-time highs.

The second chart — a longer-term one — showed the pace of the NASDAQ’s advance of the past decade. It looked downright frightening.

The third one, and the one I want to show you today, showed a divergence between price and momentum. This often indicates a larger drop to come. The chart below added a few more examples to the one I tweeted yesterday, to reinforce the point…

What are you looking at in the chart below?

Well, simply note how on each occasion I’ve highlighted, prices rose but the momentum (as represented by the relative strength index, or RSI) of the rise waned. Soon after, prices took a significant tumble.

Even the seemingly small decline in mid-2019 resulted in a 7.25% decline.

The Rum Rebellion

Source: Optuma

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So based on this indicator, the NASDAQ has a potentially rough few weeks coming up.

Just how rough depends on a lot of things: How big/bad the second wave of the virus is in the US, whether Trump tries to turn the focus/blame to China and picks a fight, and what the response of the Fed is.

I don’t know what will happen. All I know is that right now, most stocks, and certainly tech stocks, offer a poor risk/reward trade-off.

That goes for tech stocks in Australia too. Check out the ASX 200 Information Technology Index, below. Unlike the NASDAQ, it failed to breakout to new highs in this rebound rally.

In fact, the rally petered out just below the February all-time high. And over the past few weeks, divergence between price and RSI has developed here too.

It looks ominous…

The Rum Rebellion

Source: Optuma

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So, the conclusion here is that the market leader, the tech stocks, are primed for a fall.

What about at the defensive end of the spectrum — gold?

Last week I mentioned how I was worried about the near-term performance of the precious metal.

I showed you on the weekly chart how it was stretched from a shorter-term perspective, and said how its widespread popularity made me nervous about a short-term correction.

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A few days later, gold went on to mock that opinion. Gold futures broke out to new, multiyear highs, closing in Tuesday’s US trading session at just over US$1,780 an ounce.

It just goes to show that using divergence to predict future price moves isn’t a foolproof signal.

As you can see in the chart below, as gold made new highs this year, momentum waned. That was one reason why I was cautious.

The Rum Rebellion

Source: Optuma

[Click to open in a new window]

But instead of correcting lower, gold merely moved sideways for a few months. Then, earlier this week, it broke out to the highest price since 2012.

Overnight, prices moved back to US$1,770 an ounce, which is just above the February high. If stocks do sell-off in the weeks ahead, and gold benefits from defensive flows, it will be a very bullish move.

In which case, my short-term concerns will prove unfounded…


Greg Canavan,
Editor, The Rum Rebellion

Greg Canavan approaches the investment world with an ‘ignorance is bliss’ philosophy. In a world where all the information is just a click away at all times, Greg believes we ingest too much of it. As a result, we forget how to think for ourselves, and let other people’s thoughts cloud our own.

Or worse, we only seek out the voices who are confirming our biases and narrowminded views of the truth. Either situation is not ideal. With regards to investing, this makes us follow the masses rather than our own gut instincts.

At The Rum Rebellion, fake news and unethical political persuasion are not in the least bit tolerated. It denounces the heavy amount of government influence which the public accommodates.

Greg will help The Rum Rebellion readers block out all the nonsense and encourage personal responsibility…both in the financial and political world.

Learn more about Greg Canavan's Investment Advisory Service.

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