Trading The Trading Range
Another minor drop in world equity indexes in April and another snap back rally bringing most equity indexes back to multi-year or near all-time highs. The concept of risk in today’s market has melted away like dew before the hot summer sun. Syrian air strikes, saber-rattling between Trump and North Korean dictator Kim Jung-il, a rise in populist movements during the French presidential election, a realization that Trump’s economic programme and tax cuts won’t easily pass Congress, and high profile earnings misses by Goldman Sachs (GS), Danaher (DHR), and IBM — nothing matters when those who control the markets have decided that equity index are to remain at elevated levels. Welcome to the 2017 Trading Range. Almost all world equity indexes are either gyrating aimlessly since February (for major U.S. indexes) or are in slow, grinding movements (higher or lower) that seem ready to revert (back down or back up) at any moment.
Trading in a trading range is difficult. In a market where we feel that it is difficult to have strong convictions (for every bullish argument we can counter with at least one bearish argument), unsure investors are ready to believe in any strong daily/weekly movement higher or lower. By human nature, emotions affect enormously our investment decisions. After the pair of near +200 point jumps higher in the Dow this past Monday and Thursday, most investors undoubtedly became more convinced of the likelihood of Trump tax cuts and the solidity of the U.S. economy. Conversely, the prior week’s -200 point loss for the Dow may have led investors to believe that geopolitical risks and the timing of any Trump economic measures are being miss- estimated by markets. In sum, most savvy investors recognize that at some point we will see a new down- cycle in equity markets (for whatever reason that markets finally decide to latch on to). However, in the meantime, as long as someone keeps buying these -200 point dips in the Dow, investors will continue to hold out hope for one more leg higher in equities.
Trader or Investor?
We have qualified today’s equity markets as a casino. For us, there seems to be a very, very tenuous relationship between equity prices, valuations, and underlying economic fundamentals. Speculation is rife today. Betting that Trump will engineer an economic miracle, that the Fed will extricate itself from ultra- accommodative monetary policy without inducing market turbulence, and that an acceleration of economic growth will allow equities to “grow into” their current excessive valuations is, from our perspective, pie in the sky wishful thinking. Since even before the U.S. election and the “Trump bump”, we estimated that the ratio of upside reward to downside risk has been unfavourable. Despite our underlying concerns about this market, in the short-term, markets can defy market prognosticators, excessive valuations, and traditional logic. This is what we have witnessed for the past several months. Is this a market for traders (actively buying/selling) or investors (buying for at least a 1-year horizon)? We believe that we are in a traders’ market and will remain in a traders’ market until some event or significant news item (perhaps a black swan) breaks the pattern of dip buying and rapid profit-taking on rallies. While the possibility of an upside break- out is non-negligible, we question how far another upside move would run under the weight of valuations, a less-accommodative Fed, and the ripe-old age of this bull market. As investors with a sufficiently long horizon, we believe that only viable strategy is to wait for the inevitable. Remember that trees don’t grow to the sky…and waiting several years to earn back lost money is not a viable investment strategy.
In this week’s Commentary, we review several world and sector equity indexes that are either in a (1) horizon trading range, (2) in a tight ascending channel, or (3) are currently dip-buying candidates. We propose trading buy/sell target ranges on our list of indexes. Should prices pass our specified price levels given below on a closing basis, we would be forced to assume a new directional movement is beginning. For all indexes reviewed one principal applies – as long as price movements are induced by words (by a politician or a central banker) or by speculation — nothing should be bought after a rally has occurred. Equally important, don’t believe that a position will run too far, forgetting to sell and take profits. Odds are that the movement will be coming back.
Horizontal Trading Indexes
For the following indexes, it will pay to keep a contrarian mindset for the time being. Buy dips, sell rallies within the given ranges and don’t let news/media perturb your trading. These indexes can be bought and sold short to make quick profits in both directions.
Ascending Indexes
The following indexes have maintained an upward orientation since late 2016. Unlike the above indexes, we would play this group only to the upside (use rallies to take profits, but not to short).
Dip-Buying Candidates
This last group of selected indexes have come off their recent highs and have a greater potential for short- term returns as these indexes attract the “catch-up trade”. We are accumulating small position in these indexes as dip-buying opportunities. Below the specified “bailout” price levels (closing basis) we would refrain from buying. As long as broad equity indexes hold on, the following trades have a good potential to attract dip-buyers.
Conclusion
This remains a traders market and we continue to recommend that investors seeking long-term capital gains wait for the next down cycle. Contrary to current market sentiment, we will get another bear market before most readers hit retirement age! For short-term traders with a higher risk appetite seeking short-term gains, the best alternative today is forming a trading portfolio with the dip-buying candidates that we recommend above.
