Do you know what I love about fundamental analysis? Not much. Do you know why? Because they are not useful in a game where emotions make up the individuals decision to buy and more importantly sell. Fundamental analysis relies on one's ability to opine on the viability of facts and observations. Investing based off an opinion is never a wise way to invest.
You might think you are buying a stock because you "believe" in its future potential. More often than not, the truth is, you are buying the stock because you "feel" it should move higher. If that stock breaks down, begins to sell off, and you can't handle the loss anymore, you end up selling out of "fear" that it might go lower. In reality this is what happens more often than not. You would like to think that you did it because all of a sudden you think the fundamentals are bad. But you did not. It was fear that made you sell.
The decision to sell stocks is almost never about fundamentals. It is about emotions. That is the cold hard truth. The biggest problem with fundamental analysis is that it is 100% useless when looking for a top in the stock market. The truth is fundamentals are always the best at a top. Think of March 2000, think of October 2007, and think of now.
I have been trading stocks for a living since 1996. During this time, I have watched many smart fundamental investors make some very educated investment decisions. I have also watched these smart individuals lose money during every single bear market as they "believed" in their fundamentals.
The truth is the stock market does not care about fundamentals the majority of the time. The stock market can be an irrational beast that is completely dependent on basic weak human emotions. These emotions almost always cause investors to buy stocks near a top and sell near a bottom. There is only one way to eliminate these emotions and that is by learning how the stock market actually works via price history.
If you do this, you can see that there are real patterns that show up every year, every decade, and every generation. This is because the market is made up of human emotions. Human emotions never change and never will. Humans will always do irrational and just plain stupid things. We will never figure out how to fully control our emotions. As long as that is the case, a select few savvy individual investors will always be around to make money off of these emotions that show up in price and volume patterns.
I hear a lot of people talking about how Apple (NASDAQ:AAPL) and Priceline.com (NASDAQ:PCLN) is going to $1000 and Chipotle Mexican Grill (NYSE:CMG) is going to $600. I am here to tell you that while they may one day in the future, it does not appear it is going to be by this summer.
The truth is these stocks and this market is trying to top. I want to make it clear, however, that if I am wrong and we do move higher, I will simply cut my losses on the short side and buy the stocks leading the market higher. I am a trend follower. If I buy something and it moves higher I ride the wave higher. If I buy something and it moves lower, I am out. If I short something and it moves lower I ride the wave lower. If I short something and it moves higher, I am out. No questions asked.
I don't make it a habit to lose money. This is the only way to play the game. Any other form of playing this game where you do not cut your losses quickly will one day leave you with the ultimate loss. Your final loss. This is what market corrections do to those that do not use a cut loss strategy.
Before we look at why this market is topping, I will remind you one more time that fundamentals were the best at the March 2000 top and October 2007 top. The stock market tops and heads lower before the numbers do. It always has.
Remember Microsoft (NASDAQ:MSFT), Cisco (NASDAQ:CSCO), and Qualcomm (NASDAQ:QCOM) in 2000? Remember Baidu (NASDAQ:BIDU), Google (NASDAQ:GOOG), and Research In Motion (RIMM) in 2007? These companies reported earnings during these time periods that indicated short-term stock appreciation was a given. Why didn't these stocks continue to move higher in 2008? Because that cold hard truth, once again, is that the market does not move on fundamentals. It moves on human emotions.
The only way to game a market is to follow the big boys. The mutual funds, hedge funds, pension funds, and insurance funds. These are the guys that create the volume. Not me and you. We don't move $100 million to $10 billion here and there. These guys move stocks. Their movements can be tracked on a simple price and volume chart.
So let's analyze the current condition of the Nasdaq. Since the March highs, the Nasdaq has seen 10 distribution days (an index falls more than .20% on volume higher than the day before). One, two, or three distribution days are normal during an uptrend or pullback. 10 however is problematic. This amount of distribution on an index eventually weighs on it and prices soon start falling. But how do we know if this is just going to be a pullback or a real correction? The truth is you don't. It is impossible to predict the future.
However, if we look at past stock market tops by taking a look at the leading stocks during that time and then match them up with today we can get an idea of where we are at. I hate to tell you this, it looks like we are near a top.
Below are the charts of Cisco, Microsoft, and Qualcomm back in 2000.
Below are the charts of Research In Motion, Google, and Baidu back in 2007.
Below are the charts of Priceline.com, Chipotle Mexican Grill, and Apple now
Are you starting to see a pattern?
What happens is that as an uptrend starts and gets going a few top stocks start to outperform the rest due to their huge EPS and sales growth. These strong fundamentals get noticed by the big boys first and the retail crowd second. By the time the retail crowd notices that these stocks do nothing but go up, the big boys are already slowly and systematically selling to mom and pop.
Sadly, what happens next is where it finally all falls apart. On the initial pullback, like we are seeing now in Chipotle Mexican Grill, Apple, and Priceline.com, all the retail crowd that just bought or who is now waiting to buy the next pullback, start buying more.
This time, the big boys are not buying and are instead selling. What happens next is that the stock starts turning higher again but without the big boys accumulating shares the stock soon collapses on itself. Prices simply can not lift higher on thin air alone. When the next leg down starts, this is where funds that still have supply left start dumping. This is about the time when mom and pop are now trapped "hoping" that their stock will rise again.
Unfortunately, for them, stocks rarely come back. How many times was I told in 2001, 2002, or 2003 to buy Microsoft, Cisco, or Qualcomm? I can tell you. At least 1,000 times. How did that work out for those that did buy? You think they were able to find TASER International (NASDAQ:TASR) in 2003 or Travelzoo (NASDAQ:TZOO) in 2004 like trend followers were able to? You better believe not. They became bag holders collecting a dividend that was wiped out by inflation and the actual loss in the value of the stock.
The truth is that we are here again. Everyone is telling me that Apple can only go higher. I am sure it can but history suggest it will not. Who is left to buy Apple that does not already know about this story? This is Microsoft of 2000 all over again. History always repeats itself.
Now let's get into the nitty gritty with the current monthly and daily charts of Apple, Priceline.com, and Chipotle Mexican Grill.
Apple has been in a non-stop uptrend since the 2008 lows. From 2004-2008 you can see that Apple rallied the entire way on very strong volume. During the entire QE driven rally it has rallied on below average monthly volume. This is a clear sign of limited demand for the stock compared to its previous run. On top of this, we have 5 clear down months on larger volume than the volume during up months.
When we take this long-term chart into account with the current daily chart you can see during the parabolic stage of this uptrend that heavy volume distribution days came on 2/15 and 3/15 before the recent April top. Following this April top, the stock is now rolling over on very heavy selling. The selling is non-stop and it appears someone with a very large stake is getting out now. On top of this, the internal price, volume, and time indicators I use (Time Segment Volume and MACD) both topped out in March. Now price is confirming these early warning signs. Not good for recent Apple longs.
Priceline.com is not nearly as problematic but it is not beloved like Apple--this market is really all about one stock. However, Priceline.com is a clear leader when you look at EPS, sales, profit margin, return on equity, and any other fundamental matrix. It, like Apple, recently went on a very rapid price gain. These gains were basically on below average monthly volume. Compare that to the period of 2003 to 2008. This shows a lack of demand. This is another indication that this entire rally post-2008 has been a QE led melt up and not a real bull market where real demand (volume) drives prices higher.
Lately, Priceline.com has done nothing but move higher. The move higher is on higher than average daily volume but is nothing spectacular. Now the stock is selling off on volume that is much higher than anything it saw during its most recent run from the January breakout. As you can see on the chart, my internal indicators also topped out before price did. Now price is confirming the indicators. Not good for recent Priceline.com longs.
Finally, Chipotle Mexican Grill. Chipotle Mexican Grill has rallied on higher than average volume. That is until this year. As it has pushed higher this year, helping make its chart near parabolic, volume has been completely absent. This stock is almost lifting itself via magic every month. However, as you can see via the tall red bars above the yellow line in the middle window (volume), the big boys have been selling this stock the whole way up. They have been doing it very methodically. Every higher volume sell off is followed by a lower volume rally. That is until now.
Chipotle Mexican Grill has recently started to churn on volume much higher than anything during its most recent uptrend and finally cracked on Friday on very heavy volume. What should be more troubling to longs here is that my internal indicators topped on this stock back in July. Now they are finally falling off a cliff. Price should soon follow. Not good for Chipotle Mexican Grill longs.
We are nearing an end to the current rally and possibly the three year QE driven bull market. This three year rally should never have happened in the first place. Government intervention is why we had our recent bull market.
Low volume rallies were something you never saw last very long in the stock market pre-2008. If a lower volume rally occurred, a sell off was around the corner around 85% of the time within the next three months. For 125 years that was the case, via back testing price and volume in our in-house stock market index models.
Post-2008, volume has become useless for uptrends. However, for the flash crash of 2010 and for the July to August swoon, volume still worked before major downside breaks.
We are seeing the same price and volume action in the indexes that we saw before the flash crash and the July to August swoon. Maybe this time those in charge will do the right thing and let the market correct for as long and as hard as it needs to. If they do not, we will just have another low volume rally where it will be hard to make money on the long side. The next manipulated fake rally (like the 2009-2012 rally) will just eventually lead to the next brutal bear market.
Free markets need to be left alone to work properly. By all indications, if nothing was done by the Federal government during the 2008 crisis, while we might still be in a bear market or correction, we would be near the end of the down cycle. Unfortunately, we have not even started to do what is necessary for markets to work properly again.
For three years we have done nothing but move or hide the problems. We have to hide them to avoid the reality and pain of the situation. Reality is painful. The pain that has to happen is just being kicked down the road over and over. Eventually, you have to stop kicking the can. Eventually, you have to have pain. Without pain there can be no gain.
When the next bear market hits and everyone is focused on the money they have lost and who is to blame, trend followers will be sitting back, possibly smiling, enjoying the fruits of their labor. That is brutal honesty. Something you will not get from CNBC. Many people have great stories. Great stories do not make stocks move higher. Fear, greed, and hope--that is what really moves stocks. Not fundamentals. Not stories. Just fear, greed, and hope.
Additional disclosure: I may initiate a short positions in AAPL over the next 72 hours.