The Mega Trend Is the Investor's Friend

For many, Tuesday's date has a special social significance. For prudent investors, however, Tuesday is a day that this year marks a point of caution – unless you buy into one of two arguments being passed about: stocks warrant a higher than average P/E or stocks have made their lows as certain trading patterns say the bottom has been formed.

Fundamentals First

For those who favor the first point, the arguments I hear reference inflation and the appropriate P/E for stocks. Historically, when inflation runs in the low single digits, P/Es have tended to be in the higher teens – above the long-term average of 15 times. All well and good provided other conditions in the economic and financial arena are balanced - which they are not. What makes the low inflation=higher P/E argument more than a touch suspect is, frankly, a blind faith in the ability of the before inflationary pressures begin to build – which, if unsuccessful, would thereby blow up the low inflation leg of this fundamental stool.

More importantly, given the highly fluid nature of the global economic and political environment (can you say "nukes and Pakistan"?), ascribing an above average P/E during above average times of risk (despite whatever may be possible - not probable - in the inflation end of the equation) seems to require an above average degree of faith and a below average degree dispassionate logic.

Now The Technicals

As for the technicals of the market, certain technicians of the chart pattern stripe note the various breakouts as reasons supporting the “bottom has been formed” argument. There are others, however, who are purists in this chart pattern field who would counter argue that only when a completed bottom has been made in the major indices can a bottom-has-been-formed view be agreed to. Since I am not a chart pattern guy, I will leave this debate to those in the two camps. What I will put forth is something readers of this blog are very well aware of – the Mega Trend.

The Mega Trend is the Investor's Friend

Only when price is above both moving averages and the 50 day has crossed the 200 day and both the 50 day and 200 day have turned up can an investor confidently declare a Mega Trend change has occurred and a new market cycle is underway. Let’s look at the performance record in this regard using two indices as evidence – SPX (S&P 500) and EFA (Europe and Asia).

As both above charts show, when a Mega Trend occurs, that trend tends to stay in place for years. In this longer-term context, you can see that considerable improvement has occurred recently, however, neither index is fulfilled the requisite conditions to warrant a Mega Trend signal change. Price is not above its 200 day moving average and the 50 day has not crossed the 200 day. Therefore, while the 50 day has turned up and the 200 day has begun to flatten all conditions have not been met and should not be anticipated to do so until they do so. (Or as Yogi Berra would say, "It ain't over 'til it's over".)

At present, to achieve all facets of a bullish Mega Trend, stocks must build on their 30% plus rally thus far and rise significantly further from here, which, unfortunately, will produce a set of overbought conditions that are unlikely to be sustained. Moreover, any further nea- term rally would put both indices in a sharp near term uptrend, which is not indicative of the bottoming process that precedes a Mega Trend reversal. In this regard, there are several near and short term technical analysis reasons (momentum and MACD, Slow Stochastics, respectively) that argue against stocks making such a move anytime soon.

Investment Strategy Implications

To be clear, Sinko de Mayo does not mean Plungo de Mayo. It simply means equities have gotten more than a touch ahead of themselves and some contraction, a healthy contraction, would be best. Since articulating cyclical bullish sentiments in early March, readers of this blog acting on the views expressed have enjoyed a very healthy boost to their portfolios. Now, however, we seem to be at the opposite end of that spectrum for exactly the same reasons - only in reverse. Therefore, when both fundamental and technical analysis flash the yellow caution signal, it is advisable to, at a minimum, maintain the equity percentage of a portfolio through selective selling.

Going forward: Sinko de Mayo will likely be followed by Drifto the Summero leading to Uh Oh the Fallo. Enough with the bad rhymes. Let’s go make some money.

Comments

[Missing_Link:]

On May 05 05:44 PM Cetin Hakimoglu wrote:
> Sorry, but I dissagree with your article. You mention nukes &
> Pakistan, but interestngly middle east conflicts have never had a
> negative impact on the stock market.

"Has never" != "will never"

No Middle Eastern conflict to date has involved nuclear weapons.

I doubt the Taliban could get access to the Paki nuke codes, but if they did, imagine a nuke lobbed at India or a tiny, wealthy, skyscraper-filled emirate in the Persian Gulf.

Even short of nukes, the Taliban could turn Pakistan into complete chaos (a much more likely scenario IMO).

Google "black swan" and "Nassim Nicholas Taleb" ... Just because you've never seen one doesn't mean it can't exist.

May 05 08:52 PM

[Donkey Kong:]

The stock market is efficient over the long-term, but is inefficient in the short-term. If you disagree, you would NOT be an active investor (hoping to exploit anomalies) and would invest in index funds.

While North Korea is worrisome, it's a more controllable situation given the influence of China. The Taliban and other terrorist groups is a whole different story.

Lay off the Monster Energy Drinks and get some sleep. It will lead to sharper thinking.


On May 05 09:00 PM Cetin Hakimoglu wrote:

> The stock market is mostly efficient. The Pakistan Taliban story
> is reflected in the stock market, but we just can't see it. If this
> story were really such a big deal the market would have sold off,
> but it didn't. Remember North Korea missile scares back in 2006?
> That went nowhere. I'm not losing sleep over this. (not that I get
> much sleep anyway)

May 05 09:28 PM

[dieuwer:]

FXI, trades above 200 dma, golden cross imminent
EWZ, trades above 200 dma, golden cross imminent

May 05 09:31 PM

[Ricard:]

Sharper thinking yes. More entertaining, albeit at times way off, comments, no. :)

On May 05 09:28 PM Donkey Kong wrote:
>
> Lay off the Monster Energy Drinks and get some sleep. It will lead
> to sharper thinking.

May 05 10:10 PM

[Jasper M:]

Oh, god . . . he's partially right. Again. (squirm, squirm)
I suspect recent events in Pakistan have pushed the populace of that nation away from the radical case (you Don't attack cricket in Pakistan!)
And without Pakistani support, the Taliban in Afghanistan is toast. That's One thing I suspect will go Obama's way.
We have plenty of Far more pressing circumstances to deal with - that area will not be the cause of any sell offs. We will do that allll by ourselves.

May 05 10:15 PM

[User 305589:]

I beg to differ. 5% daily swings, 30%declines within weeks and 30% rises within weeks are ample of proof that these markets are NOT efficient. And, contrary what the academics claim, they are not efficient even in the long run. Ironically, index funds are and increasingly will be a major soucre for market inefficencies.


On May 05 09:00 PM Cetin Hakimoglu wrote:

> The stock market is mostly efficient. The Pakistan Taliban story
> is reflected in the stock market, but we just can't see it. If this
> story were really such a big deal the market would have sold off,
> but it didn't. Remember North Korea missile scares back in 2006?
> That went nowhere. I'm not losing sleep over this. (not that I get
> much sleep anyway)

May 06 06:48 AM

[Dave Shafer:]

305589 now you have gone and said it,

"And, contrary what the academics claim, they are not efficient even in the long run. Ironically, index funds are and increasingly will be a major soucre for market inefficencies."

Perhaps you might want to explain why this will happen!

Totally agree with your post!

May 06 11:59 AM

[Baboon:]

How do we know that the Taliban story is reflected in the stock market if we can't see it?


On May 05 09:00 PM Cetin Hakimoglu wrote:

> The stock market is mostly efficient. The Pakistan Taliban story
> is reflected in the stock market, but we just can't see it. If this
> story were really such a big deal the market would have sold off,
> but it didn't. Remember North Korea missile scares back in 2006?
> That went nowhere. I'm not losing sleep over this. (not that I get
> much sleep anyway)

May 07 01:36 AM