The Dow Jones Industrial Index has gone parabolic. (Prices are increasing and the rate of increase is increasing.) This pattern usually occurs in commodities or speculative individual stocks, rarely in a blue chip stock index. When it reverses, the steep up trend changes to a downtrend quite suddenly. Contributing editor Ken Norquay warns this could happen to the US stock market in early 2018.
The green light is still ‘ON’ for the stock market. Both American and Canadian indices touched new highs in January. The unusual part of this bull market is the little publicity it is getting. Why has the media been so silent about this roaring bull? Politics! The high correlation between the day of Donald Trump’s election and the day the market ‘took off’ has muted the US media’s coverage of this strong up trend. America’s left-leaning media likes to criticize Trump’s errors and ignore his achievements. They also like to link politics to the stock markets. For them, Donald Trump is behind the rising stock market: giving it more publicity would be left wing heresy—like giving the devil credit for prosperity.
Have we reached a high?
Normally, we recognize the end of a bull market by the excessive optimism in the investment community. But this time, because of the media-anti-Trump phenomenon, the financial press is staying silent. Is this a ‘once in a blue moon’ occurrence? Those who like to buy low and sell high are finding it more difficult than usual to judge what ‘too high’ is.
When market psychology doesn’t help our judgment, we should consider basic market mathematics. Bob Farrell, the great market technician of the late 1900s, used to teach “the reversion to the mean”. Farrell described a statistical phenomenon that arises from the market’s volatility. The market moves up or down in zigzags, not in a straight line. Technicians use curve-fitting statistics (linear regression) to make the zigzags into a straight line. The straight line is “the mean” that Farrell was referring to. Whenever the actual price gets too far away from the theoretical mean, Farrell observed that the markets would “correct” back toward the mean.
What to do?
Based on the S&P500’s January 2018 high of 2,872 and the uptrend since Trump’s election, the norm for the S&P500 is 2,728. Based on the January high and the uptrend since the beginning of this bull market in March 2009, the S&P500’s mean is 2525. In other words, if the S&P500 dropped 5 per cent, the Trump Bull market would still be intact. If it dropped 12 per cent from the high, the long-term (March 2009) bull market would still be intact. Either or both of these declines (‘corrections’) would be statistically fine within the context of their intermediate or long-term up trends. This makes today’s markets difficult for ‘buy-low-sell-high’ investors. Market math doesn’t help us any more than market psychology. What should we do?
Answer: ‘Stick to your knitting.’ Everyone needs an investment plan that tells them when they should buy and sell stocks or mutual funds. That plan is ‘your knitting’. Stick to it. Just because the market is behaving in a way you had not anticipated, do not abandon your plan. The buy-and-sell model I have been using for MoneyLetter readers is the reversal model: if the S&P500 declines 7.2 per cent from its high, sell. If it reverses 8.4 per cent from its low, buy.
By following this simple plan in the past, investors would have been out of the market during every big decline and in the market during every big uptrend. And there would be many minor buys and sells that would result in minor gains or losses. The net of it all, back tested over decades, is an improvement in portfolio performance by about 50%. In other words, if the market went up 9 per cent a year over your test period, this model went up by about 13.5 per cent. That plan is ‘my knitting’. Let’s stick to it. If the S&P500 closes below 2,666, sell some stocks or equity mutual funds.
The trend’s your friend
Let’s review the financial trends that most affect our investments.
The US and Canadian stock markets are both in uptrends. It is interesting for Canadian investors to observe how much the American stock market has been outperforming the Canadian market since 2011. This difference in performance reflects the TSX’s sensitivity to inflation and deflation, especially in the energy and materials sectors. Canada is a significant beneficiary of moderate inflation in the US economy.
Long-term interest rates, as measured by yields in government bonds maturing in 20 years or more, bottomed in July 2016 in both Canada and the USA. It appears to us that another round of interest rate increases is just ahead. The long-term trend is up. Short-term interest rates have also risen, confirming this uptrend.
The US dollar measured against the basket of non-US currencies has reversed from a long-term uptrend to a downtrend. The confirmation occurred in January 2018: the peak of the uptrend was around 103 in Dec 2016. USD dropped to 92 in September 2017, then bounced to 95 in October. In January 2018, it dropped below 92, confirming the up-to-down trend reversal. It subsequently dropped below 90. It looks like Trump’s ‘America First’ policy is still in force. He’s hoping a lower US dollar will be good for domestic job creation.
The long-term uptrend of the Canadian dollar expressed in US dollars began two years ago in January 2016. The loonie’s uptrend will be confirmed if it rises above the September 2017 high of about 82 US cents. A dip to 76 US cents would signal an up-to-down trend reversal.
Has oil peaked?
Energy prices have been in an uptrend since winter 2016, confirmed by a new high in crude oil prices in January. While oil prices have started to attract bullish speculators, the price of natural gas has lagged behind. This divergence may be warning us that the red-hot short term uptrend in oil is nearing an end.
The price of gold has been in an uptrend vs. the US dollar since the down-to-up reversal of late 2011. However, since the initial up surge, gold has not made a new high. This weakness indicates that the trend is turning neutral. It’s just fizzling out. If the US dollar continues down vs. the basket of non-US currencies, we should expect strength in gold prices. We will continue to monitor that trend, but it’s ‘UP’ for now.
Let’s also review the TSX Real Estate Index. It bottomed in March 2009 at 90, and continued up to 306 in April 2016. Since then, it has gone nowhere; it’s around 302 now. This is a list of real estate stocks in the index that are still in uptrends, having made a significant new high in 2017:
■ Altus Group Income Fund (TSX—AIF);
■ Canadian Apartment Properties REIT (TSX—CAR.UN);
■ Colliers International Group (TSX—CIGI);
■ Dream Global Investments (TSX—DRG.UN);
■ FirstService Corp (TSX—FSV);
■ Granite REIT (TSX—GRT.UN); and
■ Killam Apartment REIT (TSX—KMP.UN).
Note #1: Pure Industrial Real Estate Trust is in an up trend, but is being taken over. I did not include it on this list.
Note #2: This index lists 21 stocks, only 7 of which made new highs in 2017/18. The long term uptrend has turned neutral.
In my MoneyLetter article of March 2017, I listed five things to watch for at market tops. The article began: “This is what to look for:
1. Parabolic price rise. The price is increasing and the rate of increase is increasing . . .”
This phenomenon is seldom seen in the stock market. Usually, stock market averages roll over and fizzle out in a process that takes many months. But, since Trump’s election, the Dow Jones Industrial Index has gone parabolic. This pattern usually occurs in commodities or speculative individual stocks, rarely in a blue chip stock index. When it reverses, the steep uptrend changes to a downtrend quite suddenly. This could happen to the US market in early 2018. Please review your overall investment plan, especially your notes on when to sell. Those who remember the 1980 blow-off top in gold and silver know how fast it can happen. Those who remember the high-tech blow-off of 2000 know how far down it can go. This is a rare ‘blue moon’ event. Please review your plan now.
Those who do not have a plan, who believe that stocks always come back up, please reconsider. The Dow Jones Industrial Index has not ‘gone parabolic’ since 1929. The market has been going up for almost 9 years: that’s a lo-o-ong bull market. Because this story is not being covered by the financial press, it will seem like a surprise. Albert Einstein once said: “Those who have the privilege to know, have the duty to act.”
Ken Norquay, CMT, is the author of the book Beyond the Bull, which discusses the impact of your personality on your long-term investments: behavioural finance. He can be reached at firstname.lastname@example.org.
This is an edited version of an article that was originally published for subscribers in the February 2018/First Report of The MoneyLetter. You can profit from the award-winning advice subscribers receive regularly in The MoneyLetter.
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