By Jani Ziedins | End of Day Analysis
The S&P500 finished modestly lower on the first day back from the Christmas holiday. No real news to speak of and we should expect more of the same as we finish off 2017.
Now that Tax Reform is law, there isn’t much for traders to talk about or look forward to. And without big ideas to latch onto, the market has been treading water these last few weeks. Unfortunately for bulls the window for a Tax Reform pop has already closed. If it was going to happen, it would have happened by now. Gains over the last several months priced in tax cuts and there was no one left to buy the news. Now that Tax Reform is old news, we need turn our gaze to what comes next.
Strong earnings reports next month could extend this rally, while any bad news could trigger a dip back to 2,600. High probability of small gains versus a low probability of bigger losses. The problem for bulls is everything needs to go right to beat these already lofty expectations. Bears only need one thing to go wrong. Perfection versus the messiness that is the real world. Markets move in waves and it’s been a while since we cooled off. I don’t know what will trigger the next dip, but I do know it is coming. The only question is when.
Most likely momentum will keep us drifting higher over the near-term, but it is only time before the next problem crops up and we fall into a long overdue dip and consolidation. 2017 was a great year for stocks, but unfortunately the rarest thing is for two years to be exactly the same. If 2017 was a gentile ride higher, that tells us 2018 will be anything but easy. No don’t get me wrong, I’m not bearish. I just expect the market to consolidate recent gains and that means we will have to work for our profits in 2018.
Jani
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By Jani Ziedins | End of Day Analysis
Thursday was another indecisive session for the S&P500 as early gains fizzled into the close. This was the fourth day in a row stocks finished at the lower end of the intraday range. Under normal circumstances weak closes are a concern, but these are anything but normal times.
On Wednesday Republicans cleared the last major hurdle on the way to Tax Reform. The revised tax bill sailed through Congress and is now waiting for Trump’s signature. There is some discussion on if that will happen this month or early next month, but the day doesn’t matter much since the cuts take effect January 1st regardless.
These were the tax cuts everyone has been waiting and hoping for since Trump won the election over a year ago. And what did the market do when Republicans cleared the last hurdle? It gave up early gains and finished ever so slightly in the red. Quite the underwhelming performance given how significant this Tax Reform package is. But that is how the market works. It is always looking ahead and this tax bill was already old news.
The other complication is we are quickly approaching the Christmas and New Year’s holiday dead zone where volumes drop off dramatically. When big money leaves for vacation, it gives smaller and less rational traders control of the market. While volatility might pick up over the next several sessions, small traders run out of money quickly and most of these moves reverse within hours or days. Don’t pay much attention to the price-action when big money isn’t participating.
The market is generally feeling optimistic. Stock are near all-time highs and Tax Reform just passed. The weekly AAII sentiment survey reveals bulls out number bears by 25-points, and on Stocktwit’s $SPY stream bullishness was at 72% a few days ago. While nothing says these levels cannot get even more bullish, we are approaching extreme levels and one has to wonder where the next buyer will come from.
And that is exactly what happened Wednesday when the market failed to rally following the Tax Reform vote. Everyone who wanted to buy tax cuts had already bought, meaning there was no one left to buy the news. Momentum is definitely higher and anything can happen during this holiday lull, but bulls need to be careful. Markets move in waves and it has been a nice ride to this point. The question is if this wave is running out of steam and we are approaching a normal and healthy consolidation. Few things make me more nervous than a market that cannot go higher on good news. That is the market’s way of telling us it is ready to take a break.
Jani
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By Jani Ziedins | Free CMU
Cracked.Market University
All too often we hear the cynics claim the market is “too bullish”, or the optimists shout the market is “too bearish”. What they are really saying is they believe the market has gone too far in one direction and it is about to reverse. And they will be right…..eventually.
Without a doubt the market will reverse because it always does. Prices move in waves and I will cover the psychology behind these waves in another CMU post. (Sign up for Free Email Alerts so you don’t miss it) Unfortunately the key to making money is timing those waves exactly right. This is where popular sentiment indicators often let us down.
“Too bullish” or “too bearish” are vague and subjective. There are quantifiable sentiment measures like AAII’s weekly sentiment survey, but it is far from comprehensive and it tends to jump around. Stocktwits measures real-time sentiment in its $SPY stream, but that only tells us what a very small and highly active group of traders thinks. Other tools look at option premium, but they are equally flawed. That’s because sentiment can sustain extreme levels for months, even years.
It is best to think of sentiment as a secondary indicator. It tells us when to start thinking about something, but it doesn’t tell us when to make a trade. It is dangerous to say we should buy every time a sentiment indicator goes under 30 and sell every time it goes over 70. That’s because a 30 can stay a 30 for months or fall to 25, all while the market continues to selloff. Buying a dip a month or two before the bottom can definitely be a traumatic experience.
On the opposite end of the spectrum, sentiment has been “overly bullish” almost this entire year. It started with Trump’s election and continued all year based on hopes of tax cuts. Anyone who sold early in the year because the market was “too bullish” missed out on a nice rally. And anyone who was foolish to short this “overly bullish” market had a very painful year.
The reason sentiment measures can stay elevated for so long is they often only measure a subset of traders. For example highly active traders that fill out weekly surveys. Or the options market. While these give us a good idea of what short-term traders think, it leaves out the opinions of 401k investors who don’t follow the market. These passive investor’s opinions change much slower and this year it was their gradual warming up to the benefits of tax cuts that allowed us to rally so consistently and for so long. Even though active traders were “overly bullish”, the wider pool of investors was only beginning to warm up. And it is buying that kept pushing us higher even though most sentiment measures told us we were topped out months ago.
I love trading against extremes in sentiment, but I need the price-action to confirm my trading thesis before I will stick with a sentiment based trade. If the market doesn’t act the way it is supposed to, I bailout quickly because I know how unreliable these signals can be. Don’t let a stubborn opinion about “too bullish” or “too bearish” lock you into a losing trade.
Jani
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By Jani Ziedins | End of Day Analysis
The S&P500 stumbled on Tuesday as Congress moved closer to approving Tax Reform. The joint tax bill sailed through the House with plenty of room to spare, but a technicality means they will need to re-vote on Wednesday. The Senate is voting as I write this and it will most likely be approved by the time you read this.
If everything is going so well, why did stocks slip 0.3% and break a two-day winning streak just when everything was looking so good? It appears expectations have built up to the point the crowd now assumes Tax Reform is a done deal. Few skeptics remain and those that wanted to buy the Tax Reform pop have already jumped in. If everyone buys before the event, who is left to buy when it finally happens?
“Buy the rumor, sell the news” is a popular stock market saying and it appears like that is what is happening here. Everyone bought the rumor and the closer we get to the news, the fewer new buyers there are left to keep pushing prices higher. At this point Republicans have the votes and the rest is a formality. That’s why each new milestone is met with such apathy. If a person wanted to buy the Tax Reform pop, they missed their opportunity by several weeks. The time to buy is when the outcome is uncertain. By the time everyone knows what is going to happen, the profit opportunity has passed.
While we might get a reflexive, knee-jerk pop when both the Senate and House approve the combined bill, more interesting will be what happens after that. If the early strength fizzles and reverses, that will be a sign Tax Reform is fully priced in and the market needs to consolidate recent gains. Few things make me more nervous than a market that fails to go up on good news. That tells us the rally is exhausted.
This market has been propped up by hopes of tax cuts since Trump won the presidency 13 months ago. Once this becomes law, traders will no longer have this big thing to look forward to. The last year has been remarkably calm because minor bumps along the way didn’t bother owners who knew bigger things were coming. But now that those things have come and gone, what are traders going to fixate on? That is the million dollar question. It’s been a nice ride to this point but there are definitely warning signs this rally needs to rest. I’m not bearish by any stretch, but I’ve been doing this long enough to know that every bit of up is followed by a bit of down. At the very least we should expect a minor exhale as the market digests the last 13 months of gains.
Jani
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By Jani Ziedins | Free CMU
Cracked.Market University
Many times you hear market commentators claim an event is “already priced in” even though it hasn’t occurred yet. What does this mean, how does it happen, and what does that mean for trading? Read on to find out.
The most important thing to keep in mind is people don’t make trading decisions based on what has already happened, they trade what they think will happen. That’s because it is too late to profit on the past. If a stock already went up 10%, then it is too late to profit from that 10% rise in price. But if you think a stock will rise 10% and you buy it now, you make 10% when it increases in price. Successful traders buy before something happens, not after. This concept is obvious, but it has profound implications for how we approach trading.
As traders we are always trying to figure out what will happen before it happens. Will the next iPhone be a hit or a flop? If we know the answer before everyone else, we can profit from that insight. But since we are trading based on speculation of something that hasn’t happened yet, there are risks we could be wrong. And that risk is what creates the profit opportunity. Some people will bet the next iPhone will be a hit, while others believe it will be a flop. The current market price balances these two extreme views and every shade in between. And when sales numbers are announced, one side makes money and the other side loses.
If the outcome is random, then by rule this event cannot be priced into the market because the crowd doesn’t have insight into what will happen. But this rarely occurs because someone always knows something and eventually that knowledge spreads through the market.
Sticking with the iPhone example, we only know for sure how many iPhones were sold in a quarter when the company reports its earnings several weeks after the quarter ends. But there are plenty of ways to get ahead of the news and figure out what those sales numbers will be good or bad. The simplest is your personal opinion. Does the new iPhone excite you? Are you tempted to upgrade? How about your friends? Are they talking about the new iPhone? Do tech writers recommend upgrading or keeping your existing model? What about the lines at the launch? Bigger or smaller than last year? How quickly does the iPhone sellout? How long are backorder times? What are suppliers telling analysts about the size of Apple’s component orders? Even though we won’t know what the official iPhone sales numbers are for several months, traders paying attention to these clues will have a good idea of what the sales will be. And these traders start buying or selling based on what those clues tell them. Once those clues are obvious to the crowd, it is too late to buy or sell the news because it has already been priced in. Great reviews and the stock’s price shoots up. If most reviewers say it isn’t worth upgrading, then the price falls in anticipation of a bad earnings. If you wait to trade the earnings announcement, you will be too late.
This phenomena occurs naturally because traders are always trying to get ahead of each other. Getting there first is how we make money. We buy before the price goes up and sell before it goes down, but we can only do that if we make our trades before everyone else. And to trade before everyone else means we need to be early. And we’re not the only one who trades this way. When the crowd trades early, the expected result gets priced in long before it happens. And if the crowd is right, which it usually is, then the stock market only moves a small bit when the news becomes official. That’s because the bulk of the move occurred in anticipation of the news.
A current example is Tax Reform. Traders have eagerly been looking forward to tax cuts since Trump won the election last November. The S&P500 has risen nearly 30% since Republicans won the White House and maintained control of Congress. In finance class we learned stock prices are based on corporate earnings, but S&P500 earnings are only forecast to be up around 10%. That’s a pretty big gap between earnings growth and stock market gains. The bulk of the stock market’s gains over the last 13 months are based on hope and anticipation of regulatory relaxations and tax cuts.
If a person was waiting until Trump signed the tax cuts into law, they would have missed 30% in gains over the last 13 months. Thirty percent is a tremendous number and reflects almost all of the tax cut gains. Congress will vote on and approve the bill within days and Trump will sign it into law before Christmas. Without a doubt we could see a one or two percent pop when this happens, but one or two percent pop is peanuts compared to the nearly straight up 30% move we’ve witnessed over the last 13 months.
If a person is waiting to buy until after Tax Reform is signed into law, they are really, really late. And not only did they miss almost all of the gains, they are putting themselves at risk because following highly anticipated headlines we often run into a “sell the news” phenomena. If everyone bought in anticipation of a widely expected event, then there is no one left to buy the news when it finally happens. And the law of supply and demand dictates that if no one buys the news, ie no demand, then prices fall. So not only is the person who waits for the news too late to profit, they could actually end up losing money in the subsequent pullback. There is solid science behind the market cliche, “Buy the rumor, sell the news”.
Without a doubt the stock market can rally can continue in 2018. But we need new reasons to rally once Tax Reform becomes law.
Jani
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By Jani Ziedins | End of Day Analysis
The S&P500 started the day with modest gains, but a midday slide pushed us into the red when cracks formed in the GOP’s tax plan. A couple of Senators are withholding their support unless additional benefits are passed down to the poor. That said, the “selloff” was only 0.4% and shows the market is not all that concerned about these headlines.
The market finished pricing in Tax Cuts last week after the Senate approved its version. Rather than rally on the good news, the market actually finished lower. Going down on good news tells us most of the upside has been realized. And the same happened this Wednesday when the Senate and House agreed in principle on a compromise bill. The market gave up early gains and finished essentially flat. If anyone is waiting to buy the Tax Reform pop, they are several months too late.
The bigger risk is this turning into a sell the news event. We’ve been rallying since Trump’s election in anticipation of these regulatory relaxations and tax cuts. Now that we are only days away from realizing these pieces of good news, what does the market have to look forward to? The market ignored every piece of bad news this year because nothing could dampen the hope and anticipation of tax cuts. But soon those things are going to slip into the rearview mirror. What happens when we don’t have those overriding things to look forward to? Will bad news start mattering again? That is the million dollar question.
Markets are skeptical by nature and often fear the worst. The last 12-months of optimism has been a welcome reprieve from the typical cynicism. But as soon as the crowd gets used to the market’s mood, it changes. 2017 was a good year for stocks, but if there is one thing we can cross off the list of possibilities next year, it is a repeat of this year. Bulls can hope the rate of gains accelerate, which is a real possibility. But for that to happen the economy would need to ramp up and right now that doesn’t look like it will happen. More likely is we stumble into some bad news. Maybe some economic reports miss expectations and the R word starts getting thrown around. Or something happens in Europe. Or China stumbles. Or oil, bitcoin, or Trump. Any one of those catalysts could kick off the next correction. To keep going higher, everything needs to be perfect. To tumble, we only need one thing to unnerve traders.
For the time being things still look good, but the market is most definitely not easy and I don’t expect this gentle climb higher to continue indefinitely. The market has a nasty habit of smacking us when we least expect it and there are a lot of fat, dumb, and happy investors. But as a trader, a little uncertainty isn’t a bad thing. I make the most money when the market overreacts emotionally. This year all we had was a 3% dip on the North Korean war of words. Here’s to hoping 2018 brings us more volatility and profit opportunities.
Jani
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By Jani Ziedins | Free CMU
Cracked.Market University
Pick up any Technical Analysis textbook and you are bound to find countless examples of highly profitable chart patterns. Most books include a plethora of real-life charts showing a pattern developing, the buy signal, and the predicted move. The general idea is to memorize the various patterns, look through charts to find them, place a trade, and profit. Easy-peasy. Repeat over and over until fabulously wealthy.
Or at least that is how it is supposed to work. Unfortunately nothing in the market is ever that easy. While most of these patterns are valid and have sound human psychology principles backing them up, the problem comes from false positives. When a chart starts with the perfect setup, but it fails to complete the pattern. The idea of false positives is further complicated because so many patterns look similar. While this wouldn’t be a problem if similar setups told us to do the same thing, unfortunately most setups can give us conflicting advice.
There are countless examples where a pattern works beautifully and any Technical Analysis writer worth his salt can find charts showing the pattern working exactly as it should. The problem comes from all the false positives. How many times did this exact pattern show up and fail to behave as predicted? False positives are the bogie no one talks about and is the biggest challenge in trading with Technical Analysis.
The pure technical trader claims nothing matters except the price-action. The company name, industry, financials, profitability, news, and all the rest doesn’t matter because the market has already incorporated all of that information into the price. The pure technician believes fundamentals are redundant and he ignores them.
Unfortunately ignoring everything except price leaves out a lot of useful information. Take one of the conflicting examples I listed above, higher-high or double-top. Nearly identical setup, but much different outcome. One interpretation tells you to buy, the other tells you to sell. What should you do? Like everything in the market, the answer depends.
Most of the time the answer lies in the pieces of information the true technician ignores. Namely the news and the market’s reaction to it. No matter what the chart tells you, a stock that goes up on bad news is a great buy and a stock that stops going up on good news is one to run away from. I will dig a lot deeper into interpreting the news in another CMU post. Sign up for Free Email Alerts so you don’t miss it.
Now don’t get me wrong, I’m not bashing the usefulness of Technical Analysis. It is a great tool and I use it every day. But like any tool, it has its limitations. Successful traders recognize profitable patterns, but they also recognize the false positives. Or which pattern is more meaningful when similar setups are giving conflicting recommendations. Learn and use Technical Analysis, but always be aware of the risks posed by false positives and develop a process to weed them out.
Jani
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