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Price action is considered a crucial element in technical analysis. Technical analysts attempt to react to what the market is telling them while fundamental analysts try to predict the direction of the market. The dilemma with predicting/forecasting is that one can lose a lot of money if one’s predictions/forecasts are turn our to be incorrect, while the benefit of observing price action is that it provides one with ample opportunities to get out of trades with minimal losses, lest they be wrong or get into trades if the price action confirms a bullish trend. In order to learn one technical analyst’s reaction to the market, I turn to Tom Akin, technical and quantitative analyst at Research Capital Corporation

Bio: Tom Akin is a technical and quantitative analyst with nine years experience, most recently with Research Capital Corporation. He holds a Chartered Market Technician designation (CMT) from the Market Technicians Association and was ranked 2nd in technical analysis and 3rd in quantitative analysis in the 2008 Brendan Wood Institutional Investor Survey. Tom began his career in 1999 with TD Securities Inc. after graduating in 1999 from the University of Western Ontario with a Bachelor of Science in Mathematics.

Q: Mr. Akin, in the face of the recent volatility in the stock market, a number of Elliot wave practitioners are calling the recent rally from the lows a bear market rally and that we are now in a secular downtrend, does your analysis concur with this view?

A: I don't really utilize Elliot Wave analysis as it takes an enormous amount of practice and requires a long history of study and understanding. Additionally, a lot of patterns in technical analysis can't really be recognized until they are completed, and as such, it is potentially dangerous to identify formations before they have had a chance to satisfy themselves. For example, a head and shoulders looks like normal market action after the first shoulder and head at the point of the bottom of the right shoulder. Only after the right shoulder has formed and the neckline is being tested are we more confident of the pattern. As such, I prefer to try to react to what the market is telling me and not try to identify larger overall secular patterns before they become obvious.

And what the market is telling me is that this isn't your father's standard bear market rally. After this far, this fast, it is difficult to believe that we are still in a bear market. We would need to be at the beginning stages of a depression that would rival the great one of the 30s for this rally to simply be a fakeout/hope trade. And I just don't believe the underlying economic and earnings factors are as bad as they were then. As such, it is a fair possibility that the bottom has been seen, at least for now (secularly). I would say that I am not expecting new lows or an immediate return to lows at any point soon. That being said, I am also anticipating that 2010 is going to be a very tough year for investors and traders alike. Volatile, mostly sideways action is a reasonable expectation after the scope and nature of the rally we have had, much like 2004 following the final 2003 low in what turned out to be a triple bottom.

Despite the fact that a new bull market had dawned, 2004 was a year when the S&P 500 was very volatile and ended up net down around 10% after 9 months of chop. It was very difficult to trade. 2010 could very well end up similarly. We will be facing more difficult year-over-year comps in 2010 than we were in 2009 . Additionally, overbought conditions and valuations may dictate an investor attitude of demanding economic and earnings results that start to show that they are actually recovering more strongly rather than simply not getting any worse.

Q: What are the technical and quantitative factors telling you about the TSX Composite as we move into 2010? Do you have any near term pivot points of support and resistance for the TSX Composite?

A: 11,500 has proven fairly strong resistance up to this point. From a sector perspective, of the three drivers of returns, Energy and Financials appear to have topped for now, with only Gold having been capable of reaching new highs. This may limit the overall Composite going forward. Beyond this, at 12,500 (only 1000 points away), I see very strong resistance from 2007-2008 where the level was defended multiple times by the bulls before the Lehman bankruptcy finally caused it to fail. A consolidation between 10,500 and 12,500 could be the story of 2010 based on my view of sideways/volatile markets in the near-future. Of course with this in mind, we must still be respectful that the market hasn't told us that it is doing this yet, but it's my best estimate to this point. We will continue to react to breakouts or breakdowns that will ultimately tell us what the right view on the market is.

Q: What are your thoughts on the energy sector? In a recent note, you contended that oil is oversold relative to gold - can you please elaborate on this and your reasons for coming to this conclusion? Also, what are your thoughts on natural gas going forward?

A: The story in commodities is the weak U.S. Dollar. Interestingly, however, although Crude Oil is 90% <negatively> correlated to the U.S. Dollar over the last year, and Gold only 70%, Crude has gone down during the last couple of weeks of U.S. Dollar weakness and incredible strength in Gold. This sets up a situation where Crude is oversold relative to Gold and in the context of the U.S. Dollar and may be an opportunity to buy Crude in the very near-term. In situations like this, Crude can either play catch-up, or would be defensive in a commodity pullback since it didn't participate on the way up.

Natural Gas is a tougher story. The supply situation is at record highs according to the DOE, and the futures complex is complicated by significant contango in the term structure. I believe inventories are rolling over and this might provide another bump to Natural Gas prices as the fear was that they would hit maximum storage and prices would be under even more pressure. Additionally, Oil and Gold both hung onto seasonality longer than expected, so why can't NatGas? I will probably remain cautiously bullish of Natural Gas until the spring when inventories will probably be bottoming at already high levels historically. I'd like to see one more push into the stocks before then.

Q: Given that cyclical stocks have outperformed defensives in this rally since March 2009, can you please highlight one sector among Canadian stocks (e.g. can be financials, energy stocks, technology, resources etc.) that you believe to be overbought/overvalued and due for a correction and one sector that you believe to be oversold/undervalued and due for a bounce and why?

A: The cyclical/non-cyclical issue is potentially more complicated than many believe. I prefer to take resources out of this equation as they are a different kind of cyclical where it's all about the underlying commodity price, which has seasonal and supply-demand factors that don't necessarily have to do with the state of the economy. If you look at growth (non-cyclical) versus value (cyclical) in the U.S. where commodity sectors are not very highly weighted, it is true that cyclicals outperformed after March. But non-cyclicals have actually taken back over and held their long-term uptrend relative to cyclicals from August to present. This is one of the reasons why I am worried about the state of the rally heading into the New Year. This is one underlying market machination that is suggesting the rally could soon come to a peak.

A cyclical sector I would be wary of in a pullback would be Retailers. We saw downward revisions across the board on their last reports while the recent technical patterns appear to be breaking after a reflation rally. As such, names like Canadian Tire (CDNTF.PK), Gildan Activewear (GIL), Rona (OTC:RONAF), Reitmans Canada (OTC:RTMNF), Forzani Group (OTC:FRZNF), etc., could be at significant risk going forward.

A non-cyclical group that is looking brighter is Grocers. We saw upward revisions across the board when they last reported, while the stocks are much closer to support lows than most other stocks and starting to rally off of lows, demonstrating more definitive technical strength in the intermediate-term.

There are always cyclical areas that can be hot, however. We have seen strong intermediate trends in Water Treatment/Filtration companies recently, such as GLV Inc. (OTC:LVGAF) and Bioteq Environmental Technologies (OTC:BTQNF). We continue to look for breakouts from bases in these stocks. A non-cyclical group that looks weak to us are Banks. Technical patterns in this area are very weak and toppy, with uptrend lines being violated.

Q: Lastly, can you please highlight one stock/ETF/commodity that you think offers the best technicals/value moving forward and your reasons for liking it?

A: I try to avoid the top pick/bottom pick because there are too many criteria when discussing the overall market. Large/Small, Cyclical/Non-Cyclical, Resource/Non-Cyclical, names we wouldn't buy yet but are watching for a breakout, something that's just crossed its 200-day MA, etc.? There's always a style, sector, and risk decision that investors should make before making any purchase, and hence why a top pick is moot. I need to know the style, sector, and risk decision before I can then say, "OK, here's what I would buy."

But let's shoot for something that is at least digestible for most and say large cap/liquid, medium to medium-high risk tolerance, and resource sector. I would select Potash Corp. of Saskatchewan (POT):

  • Testing intermediate highs from spring at US$120, after staging a rally off of support at US$90
  • Price ratio relative to closest comp AGU is back up above 1.9x after a false breakdown, and has room to run to 2.5x area, in our view
  • DAP, Urea, Ammonia prices improving which should be good for overall sector
  • Although strongest month for market is December, it is by far strongest month for potash companies such as POT and MOS
  • Foray back to overbought levels suggests slightly overbought condition and buying on weakness to setup a breakout.

Thank you Mr. Akin!

Disclosure: I do not hold any positions in the stocks mentioned.

Source: Tom Akin: Don't Sell a Bullish Trend Until It Is Proven Otherwise