January 2015 – Adaptiv

Month: January 2015

Proof That Cash Is A Position Too

January 29, 2015April 13, 2022

Those who check out our work often, know that we are advocates of patience, risk management, and high probability asymmetric risk/reward scenarios. This is a fancy way of saying we like to minimize loss while maximizing gain. Isn’t that what every investor wants? Related to our approach, we have been known to tell our readers that “cash is a position too.” In this article, we’ll show you just how valuable cash is as a position. At this point, it needs to be made clear that there are many opinions about the functionality and validity of fiat currency. That is not what this article is about. We are not here to debate whether the U.S. dollar is worth the paper it’s printed on. We are writing to show you that holding U.S. dollars is a valid investment position and one that can protect your capital.

To show you this, we’re going to use ratio analysis, a valuable instrument in our tool box. This approach of comparing the price of two securities against each other as a ratio is valuable in identifying opportunities. Today, we’re using a ratio of the U.S. Dollar Index (USDX) versus the S&P 500 (SPX). The U.S. Dollar Index is our proxy for the value of (you guessed it) the U.S. dollar. This index uses a weighted mean of the dollar’s value relative to other select currencies. When USDX rises, it indicates U.S. dollar strength and when it falls, U.S. dollar weakness.

In the weekly chart below, we’ve divided the USDX by SPX (the S&P 500). Our ratio (dollar/S&P 500) is in the upper panel and the S&P 500 is by itself in the lower panel.

When this ratio moves upward, the dollar is outperforming the S&P 500. When the ratio moves downward, the S&P 500 is outperforming the dollar. For the majority of the time, as you would expect, the ratio travels downward because the S&P 500 is outperforming the dollar. But when the ratio turns upward, investors should take notice. Based on this simple ratio, we know when holding the dollar is more valuable than owning U.S. stocks. Take a look at the chart (click it to enlarge). What do we see? We see that this ratio moves in relatively predictable trends. Notice the price trends identified within green channels (1995-2000) and descending triangles (see 2002-2005, 2002-2007, 2009-2011, and again during 2012-2014). These downward patterns are highlighted in green and when the downward trend has been broken, and the ratio moves up, we’ve annotated the chart with vertical black and orange dashed lines. The orange dashed lines indicate times when this ratio broke upward and the S&P saw a major correction or bear market. The black dashed line indicates a minor correction within the market when the ratio broke upwards. As you can see, starting back in October 2014, the ratio broke its upper trendline. From that point forward, investors have been better off holding U.S. dollars than owning the S&P 500. This is significant. With the dollar outperforming the S&P 500, it tells us that major money managers are seeking safety. Now is a time to pay close attention to U.S. stock markets. Will the dollar continue to outperform the S&P 500? Could this be the start of a minor correction or a major trend change for the S&P 500? No one knows for sure, but the warning signs are abundant [1]. In the end, we’ll let price guide us.

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[1] You can read more about the warning signs we’ve identified via our seven part series:

[the following chart was added on 02-04-2015 to show USDX next to the S&P 500, no ratio, dashed lines in same exact locations as the chart above]

Equity

Consider Taking Some Of Your Paycheck To Buy Paychex…

January 25, 2015April 13, 2022

Paychex, Inc. (PAYX) has a lot going for it. This commercial services company recently expanded its outsourcing capability with three notable value-adds:

A cloud-based time and attendance service (bolt-on via its acquisition of Nettime Solutions last June)
A mobile time-punch application called Paychex Time
A health care product that helps clients navigate the complexities of the Affordable Care Act

In addition, their client retention level is 82% (an all-time high), their quarterly dividend has tripled since 2005, and their previous quarter earnings were up 9% while revenue grew 10% (the best in over four years).

More importantly, last week, PAYX broke through overhead resistance to new 52-week highs. The move comes after an 11-week price consolidation. Corrections take place in one of two ways – through price (declines) or through time (sideways price consolidation). Of the two, a correction through time is the most powerful. This bullish continuation pattern in PAYX has formed within an uptrend (note the upward price channel on the weekly chart below). In addition, last week’s breakout took place after a previous breakout from a bullish cup formation (see rounded line on weekly chart below) that took 45 weeks to form. That is a real nice base. Technicians know, “the longer the base, the higher the space.”

What’s great about price patterns is that our risk and reward are well defined. In this case, our reward target is 55ish, a 14% gain. And we can choose one of two stop loss levels to manage risk – either 47.00 (below previous weekly resistance now turned support) or tighter at 47.50 (a logical support level on a daily basis).

We have our entry (right now), our stop loss, and our target. We don’t enter a trade without an exit plan. So we have our game plan and will enter this trade because of the robust risk/reward opportunity. If we get stopped out, we don’t care. That means our risk management is solid. We’ve removed the emotion while identifying great potential gains. Enjoy.

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Equity

Important Levels On S&P 500 (SPY) Identified

January 17, 2015April 13, 2022

Over the past two months, we’ve provided evidence that the probability of a correction in the US stock market was increasing. We have not made a full blown correction call because the most important piece of evidence still pointed to higher prices in the overall US stock market. However, that most important piece of evidence, price, has begun to capitulate. What does that mean? If you remember our article about price, you’ll remember that it is the only thing that matters. You can have every indicator, piece of inside information, or strong opinion you want. In the end, price is always right [anyone envision Bob Barker when you read that?]. Price trumps all other pieces of information you deem to be important. And since releasing our research, price has begun to deteriorate. The price of the S&P 500 is lower than it was when we began to identify problems back in November. It is time to pay close attention to price action in the near term. The U.S. stock market (represented in this article by the S&P 500) must re-establish new highs quickly or risk a trip to the 1800s (which increases risk of lower lows if that take place).

Using the chart below, we’re going to identify some important levels. Every trade we enter has to have an entry and exit plan. If we are going to establish a long position in the S&P 500 using the ETF, SPY, we need to know where to enter, when we’re wrong, and when to exit. The same is true for taking a short position. For us, we’ll us ETF, SH, to establish a short position on the S&P 500. As annotated on the chart, our game plan is to change from long to short with a daily close below 200.00. This is our if/then line. We are long above it, short below it. If price moves below 200.00, we would add to our short position with a close below 197.00. Keep in mind, that we will need to nimble with our short trade as we would be going against the upward price trend (as identified by the “360 green” channel). Each of the shaded areas and the lower green trend line would be logical places to reassess what price is doing and either add to our short position or change back to long. At each of those levels, we’ll analyze price and make adjustments as needed. With risk management, no game plan is static. We continually reassess our game plan to minimize loss and maximize gain. This game plan is not for everyone. We’re not saying going long or short is right for you. Cash is a position too. Some of the best trades are those that aren’t made.

Trade safe.

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Equity

Unique Index Provides Insight Into The Current State Of…

January 15, 2015April 13, 2022

It’s important to take a look at price, markets, and trends from different angles. Any edge we can gain in identifying opportunities is valuable. Today, we’re writing about an index that you might not be aware of, but that is very helpful in gaining insight into the current condition of the U.S. stock market: the Value Line Geometric Index (XVG). This index tracks the median move of stocks within the index using the assumption that each stock has an equal amount (for example, $1,000) invested in them. The daily average move of this index is calculated geometrically (rather than arithmetically). I don’t want to bore you with the details, but if you need more info, you can read more about the methodology here, page 4. More simply put, this index eliminates an illusion created by weighted index components. Weighted stocks within an index can pull it higher even as the majority of the stocks within the index are not following along. For example, in a weighted index like the S&P 500, it’s possible for the top 100 weighted stocks to carry the index higher while the remaining 400 stocks lose value. As an investor, it might be helpful to identify when this is happening.

We previously released research that provided a similar approach by looking at the percent of S&P 500 stocks that were above their 200 day moving average. In the same way, by looking at the Value Line Geometric Index alongside the S&P 500, we gain valuable insight into what is currently taking place in the market. Looking at the chart below, the Value Line Geometric Index is in the upper panel and the S&P 500 in the lower. Notice that the equal weighted Value Line index is struggling to break its previous highs from 1998 and 2007 while the S&P 500 has continued higher (divergence). This condition has been persistent since March, 2014. This means the market is thin: money is flowing into large cap stocks and leaving the rest behind. This is a stock picker’s market and can be a hallmark of market tops. It should be noted when looking at the chart below that this condition can persist for quite a while before there is an overall resolution to the market (aka a correction in price). In the past, a noticeable divergence developed between the equally weighted index and the weighted S&P 500 before the S&P 500 corrected in price. This doesn’t mean the S&P will correct in price right now or at all. But, it does mean that it is getting harder to find U.S. stocks that are trending up. And as long as this condition is in place, we’ll be watching the price of the S&P 500 closely. You should be too.

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Education

How We Identify Opportunities: The 360 Process

January 13, 2015April 13, 2022

We work our craft. Continuously.

Research. Identify. Trade. Share. Rinse. Repeat.

Equity

A Little Fear About The FEAR Index

January 10, 2015April 13, 2022

Back on November 13, 2014, we wrote about our concern over elevated volatility as part of our seven-part series on evidence currently warning of a possible trend change in the overall U.S. Equity market. Almost two months later, none of the issues identified have resolved and remain cause for concern that stocks are weakening and could lead to a large correction. The only piece of evidence, and the most important, that has held up is price. Since November 13, the S&P 500 has traded sideways in a volatile fashion with large percentage moves in either direction. The market is at a very important inflection point. Buyers need to step up in a big way to prevent another visit to the 1800s (-10%) on the S&P 500.

This brings us back to revisiting what is currently taking place with the FEAR Index, or VIX. As a reminder, the CBOE Volatility Index (VIX) is a forward looking instrument calculated from option activity, and reflects the market’s expectation of 30-day volatility. We like to look for divergences between the VIX and the US Market. We look for odd behavior. Normally, as would be expected, when fear/volatility increase, stocks decrease in price – and vice versa. However, sometimes a change in market sentiment from greed to fear (and the opposite also applies) can tip its hand. When we see fear/volatility increase along with market prices, we take notice. This is odd behavior and could be a warning sign that market participants (big money managers) are changing their mood. This was taking place back in November and continues to be an issue today. As George Soros once noted:

Volatility is greatest at turning points, diminishing as a new trend becomes established.

The chart below is an updated version of what we provided you back November. Note that volatility has continued to increase, both in the VIX and now in the price fluctuations of the market. This needs to resolve quickly. Those long this market need volatility to drop and new highs in the market to reestablish. Otherwise, the opposite will apply – new highs on the VIX and new lows in the market. A revisit to the 1800s would be likely. This market will require traders be nimble in the coming weeks+. Keep in mind that price is the final arbiter of value.

For your reference, I’ve provided a chart of this scenario from the 2007 top below the current day chart. This doesn’t have to play out again, but we should always sit up and take notice when volatility increases.

Trade safe. Don’t trade what you think. Trade what you see.

VIX Fear Index 2007 — 2007 Elevated Volatility

China

Relative Rotation Shows US Equities Leading | Opportunities Possible…

January 8, 2015April 13, 2022

We live in the golden age of investing. Never before have individual investors had so much available to them for gaining investment knowledge, finding great investment opportunities, and the ability to take advantage of them at such a low cost. Our parents could only dream of having investment communities like seekingalph.com, investment blogs like [shameless plug alert] opportunityidentified.com, almost limitless fundamental information online, and technical analysis tools like stockcharts.com only one click of a mouse (“what’s that?” says your grandpa) away. And with the advent of ETFs, common investors can invest in pretty much whatever and wherever they want. Want to buy timber? Go for it. There’s an ETF for that (WOOD). How about palladium? Got you covered (PALL). Want to invest in foreign markets like South Korea? Be my guest (EWY). Do you really like coffee? Try JO. With sugar? Sure! (SGG). Investors today have the investment world at their fingertips.

At 360 Investment Research, we like to take advantage of another amazing tool available to all who want to use it: Relative Rotation Graphs (RRG) Charts™ [1]. These charts show you a security’s relative strength and momentum relative to a collection of other securities. Developed by Julius de Kempenaer of RRG Research, RRGs help us identify where we should be invested, or be looking to invest, within a universe of investments. Decisions should not be based solely on RRG analysis, but these charts definitely help us focus on those areas of the investment universe that deserve it. They give us the big picture within one picture. We appreciate their usefulness and you should too.

In this week’s RRG™ analysis, we’re going to look at the relative strength of the world’s largest markets, using the total world ETF from Vanguard (VT) as our benchmark. Basically, we want to see where in the world we should be focusing our attention. Accordingly, the following ETFs representing most of the world’s largest stock markets will be compared against VT:

SPY (S&P 500)
VTI (U.S. Total Market)
EWC (Canada)
EWQ (France)
EWG (Germancy)
EWI (Italy)
EWP (Spain)
FEZ (Europe)
PIN (India)
GXC (China)
MCHI (China)
EWY (South Korea)
EWH (Hong Kong)
EWJ (Japan)
EWA (Australia)
RSX (Russia)

Generally speaking, when looking at the ETFs above in the RRG™ below, those in the green leading quadrant are what you want to own; those within the yellow weakening quadrant should be on your watch-list (as they might be deteriorating), those within the red lagging quadrant should be avoided and those in the blue improving quadrant should be on your shopping list.

In the RRG™ below, the long tails represent the movement of each country’s ETF over the past 10 weeks in comparison to the world ETF, VT. So what do we see? The first thing to notice is the chart of VT in the upper right corner. Global stocks as a whole are down since July. Accordingly, when we analyze this chart, we want to be cognizant of the fact that maybe stocks as a whole are not where we want to be. That being said, if we are looking for stock opportunities, we see that we should be in the US (SPY and VTI have been leading the last 10 weeks) and looking for potential opportunities in Germany (EWG), France (EWQ), and Europe (FEZ) as they have moved from lagging to improving over the past 10 weeks. And finally, we should also look to China (GXC and MCHI) as they are subtly rotating from weakness towards leading.

In conclusion, if we have to be in stocks, we should be in the United States and looking for potential opportunities in Germany, France, Europe, and China.

[1] Note: The terms “Relative Rotation Graph” and “RRG” are registered trademarks of RRG Research.

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(click chart to enlarge)

Cycles

What Does the Decennial Cycle Say About 2015?

January 4, 2015April 13, 2022

The decennial cycle is one of several cycles we look at when doing our investment homework. It’s an important cycle that dates back to the late 1800s when Charlie Dow first created the Dow Jones Industrial Average. This pattern considers the stock market performance in years ending with the same number. Currently, we are in the early stages of 2015, which is the fifth year of this decade. In our cycle study, we include this year with 2005, 1995, 1985, 1975 and so on. And upon reviewing the data, it’s clear that the 5th year of the decade has an amazing track record. The average return for the Dow Jones Industrial Average since 1895 for the 5th year of the decade has been 28.93%! Just as impressive (if not more so) is the consistent performance of 5th years. In fact, 11 out of the 12 5th years were up with the exception of 2005, which experienced a calamitous -0.61%. [thick sarcasm]

The first chart below shows the impressive consistency of each decade’s 5th year. The second chart below shows just how significant year 5 is compared to other years in the decennial cycle. No other year comes close to having the returns that year 5 has seen.

As impressive as this research is, we’re not going to trade solely on this information. But, we think it’s valuable to keep an eye on it as we head into this 5th year. The decennial cycle certainly suggests the current bull market will continue. Anything opposite will be historic.

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Education

Our 360 Commitment

January 1, 2015April 13, 2022

Dear Reader and Curious Investor,

We are committed to you. During 2015, we are on a mission to provide you quality investment ideas and information at least three times per week. So check opportunityidentified.com often for great investment opportunities. These investment opportunities are identified using our propriety library of indicators, charts, and resources. The easiest way to follow our work is to sign-up for our free email notification service (click here to sign-up).

Why are we doing this? We put a great deal of time, effort, and expertise into our craft. We don’t share everything, but for 2015, we’re going to share a great deal of information, ideas, and education with our readers. So why are we sharing great investment information for free? To raise awareness about 360 Investment Research and the valuable work we do, identifying asymmetric risk/reward opportunities using technical analysis. We want you to see what we see. What do we ask in return? Quite simply, if you find our information valuable, share the wealth with a friend.

Committed to you,

David

Founder, 360 Investment Research, LLC