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Matthew Crews, CFA is a registered representative of Smith Patrick Financial Advisors, LLC, a fee-only advisor in Saint Louis. Matthew's focus is on building durable portfolios for clients using a wide range of ETFs for diversification. Given that clients portfolio's don't exist in a vacuum, Mr.... More
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  • Symmetrical Triangles Indicate A New Trend Soon 2 comments
    Aug 3, 2012 11:10 AM | about stocks: EEM, EFA, IWM, PID, SPY, XLI

    "Two men enter, one man leaves"

    Mad Max Beyond Thunderdome

    After a stellar first quarter and a swoon in May, the equity markets have entered a choppy/sideways period. This has made it difficult for investors that rely on trend-following systems.

    To add additional insight to aid in the tactical asset allocation process, I have stepped back to a longer time frame and used basic trend line charting to highlight the various equity markets. The following is a review of how I see things unfolding in the broad equity markets. (In future commentary I will review fixed income and alternative investments.)

    In short, outside of large cap domestic stocks, most broad-based equity indices have been coiling into symmetrical triangles that will likely resolve in the several months or sooner. Symmetrical triangles are the creation of an upward and downward trend at the same time. Ultimately one trend will win out.

    Base on the continuation of these various symmetrical triangles - it is reasonable that the various equity markets will tighten around their long-term moving averages (which are the 10-month moving averages in this note). Therefore, expect intermediate trends to flatten out and/or become less-reliable until these patterns resolve themselves.

    Given that leadership in the markets over the past 12-to-18 months has shifted to defensive sectors in the domestic US large cap market, the bull market is on its 4th year, and global economic growth continues to slow -- I believe more consideration should be given to a potential negative outcome. Until volatility really picks up (say with a couple of 3% daily up/down swings in the S&P 500) I don't think there is enough fear in the market to play a contrarian strategy. Patience should be rewarded here.

    Domestic Equities

    Large cap domestic equities continue to outperform their peers on an intermediate-to-long term basis. Domestic large cap stocks have held their long-term trend set back in March of 2009. Underlying the performance over the past 18 months however has been strength in the early-cycle sectors (housing, consumer, technology) but also defensive sectors like consumer staples and utilities. Mid-cycle sectors industrial, basic material, and the energy sectors have underperformed.

    Figure 1: Domestic Large Cap Blend (NYSEARCA:SPY)

    (click to enlarge)

    Looking closer at large cap domestic stock performance will show that not all sectors have been making higher highs. Several sectors that I consider mid-to-late cycle (Industrial, Basic Material, and Energy) have begun coiling. It has been consumer-oriented sectors including housing as well as defensive sectors (health care, utilities) that have provided the recent boost in performance.

    Figure 2: Domestic Large Cap Industrial Sector (NYSEARCA:XLI)

    (click to enlarge)

    Domestic small cap stocks have not kept up with domestic large cap stocks either. This is just another indication that the market overall has down-shifted its risk tolerances and moved to the large cap domestic defensive sectors.

    As the symmetrical triangle resolves, we could see the 10-month moving average be whipsawed over the next couple of months.

    Figure 3: Domestic Small Cap Blend (NYSEARCA:IWM)

    (click to enlarge)

    International Equity

    International stocks have a similar symmetrical pattern that has evolved since 2011. The symmetrical triangle not unsurprisingly based on Europe's current currency and debt crisis looks more like descending triangle which has more negative implications. The more value-oriented PowerShares International Dividend Achievers ETF (NYSEARCA:PID) has a slightly more healthy looking profile (not shown).

    Figure 4: International Large Cap Blend (NYSEARCA:EFA)

    (click to enlarge)

    Emerging Markets Equity

    Lastly, emerging market stocks also have developed a symmetrical triangle starting with the peak in 2011. The emerging markets seem to be the only group that set a lower low in 2011. However, the triangle is set and looks like it will be resolved very soon. As with the International stocks, I suspect the emerging markets also to coil around the 10-month moving average over the near-term.

    Figure 5: Emerging Market Large Cap Blend (NYSEARCA:EEM)

    (click to enlarge)

    Conclusion

    The sideways trading in the equity markets has made short-term trends unreliable. From a basic chart perspective, it seems as though the majority of markets are resolving between the longer-term bull market established in 2009 and the recent peak in 2011 which marks the beginning of a global economic slowdown.

    The 10-month moving averages will likely be less reliable over the next several months as long as the various triangles continue to resolve. However, we should expect a new trend to emerge over the next several months as to the direction of the markets.

    As noted in the beginning, leadership in the markets over the past 12-to-18 months has narrowed to defensive sectors in the domestic US large cap market. With an aging bull market and global economic growth slowing -- I believe caution is warranted. While volatility has been picking up, until we see a couple of 3% daily up/down swings in the S&P 500, there is not enough fear in the market to play a contrarian strategy.

    Disclosure: I am long SPY.

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Comments (2)
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  • Matthew Crews
    , contributor
    Comments (108) | Send Message
     
    Author’s reply » Looks as though when rolling into September -- several indexes are trying to breakout including EFA and VEU. EEM remains in a quagmire.
    5 Sep 2012, 05:11 PM Reply Like
  • Matthew Crews
    , contributor
    Comments (108) | Send Message
     
    Author’s reply » We have had a fair amount of moment here and therefore I will update these charts at the end of November.
    16 Nov 2012, 10:57 AM Reply Like
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