The Deipnosophist

Where the science of investing becomes an art of living

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Location: Summerlin, Nevada, United States

A private investor for 20+ years, I manage private portfolios and write about investing. You can read my market musings on three different sites: 1) The Deipnosophist, dedicated to teaching the market's processes and mechanics; 2) Investment Poetry, a subscription site dedicated to real time investment recommendations; and 3) Seeking Alpha, a combination of the other two sites with a mix of reprints from this site and all-original content. See you here, there, or the other site!

16 May 2007

Signs of Change, noted asyndetonically

One reader queries...
Given the seeming weakness in retail this quarter, are you still as bullish on JCG? I'm not exactly sure what to qualitatively make of the retail and consumer data coming out recently. It seems to be the driving force in today's (5.10.2007) market sell off especially. I still like JCG from a management and technical standpoint but just looking for some other insight.

Also, got any opinions on the broad market?
Peridot Capitalist made an interesting point a few weeks ago about a 7 year double top in the S&P. Could we be seeing that? Or do you think we're just looking at a little bit of resistance at 1500 with an eventual breakout through the old 1527 mark?
Excellent questions, Dan. First, re J Crew/JCG, I remain powerfully bullish because the opportunity itself remains profoundly bullish. Oh, sure, there will always remain those damnable oscillations in the markets, but in the end the cream always rises to the top.

I choose instead to focus on two items you also note: the company's excellent management and the solid position of its chart. One could characterize my analysis as more bottom-up than top-down; yes, the sector and group analysis I perform is top down, but everything after that is bottom-up. Short term price oscillations aside, I like JCG -- a lot. So you will find me holding my investment lots during market declines, and even purchasing more at the appropriate price points (say, ~$35). Successful investing is all about patience -- sitting through the markets' periods of chaos, which trumps each time the frenetic in & out chaos of trading.

It is your second question that has me thrumming with resonance. First, re Chad's analysis of a double top in the S&P -- two peaks make for a potential double top; the confirmation would occur only with a breach beneath the interim low, in this instance, at ~768.63. That is quite some way down from here, which leaves ample room for sizable declines and lots of movement between the interim highs and lows, all without confirmation of a double top. Really, in any case, I do not perceive the markets as a monolith; i.e., if the market indices decline or rise, then it does not follow that all the publicly traded stocks decline or rise concurrently. Such an event is exceedingly rare.

However, change in the markets does seem afoot. I predicate my top down analysis, as it is, on the movements, both intermediate and secular, of the US$. Somewhat self-aggrandizingly, allow me to say my 'calls' re the direction of the US$ have been uncannily correct. But all to no avail; despite my fears, the decline of the US$ has been met with a barely stifled yawn by the markets. At least the markets as capitalized in US$, which have rallied resolutely. The brief snippet and chart below are each by Dorsey Wright...

A falling US Dollar can help American firms selling products overseas, as they can more easily gain market share as their products become cheaper to foreigners. But investor flows from overseas are hurt by a weak dollar, as those investors are entering a dollar-denominated investment at the expense of something that is likely denominated in their own currency. So, foreign investors have seen the purchasing power of their Euros and Pounds increase significantly over the past six years, but had they invested in various equity markets that were denominated in US Dollars during that time, the conversion back to their own currency becomes a sobering reality. Meanwhile, US investors have seen the Dow Industrials rocket to new all-time highs, but could nary afford a cappuccino if they were to travel to London, much less a place to stay. Our dollars are worth less (and less, and …), which means it takes more of them to buy just about anything, including our equity indices. A foreign investor that sold Euros to buy the Dow Diamonds [DIA] on the AMEX is yet to get back to even, despite the fact that we see the Dow breaking to new highs as denominated in US Dollars.

[click on each image to enlarge]

Commentary and chart courtesy (c) Dorsey Wright Analytics

A quick look at the price action of the US$ shows this all too clearly...

As ugly as it appears right here, right now -- as the US$ stands on the cliff's edge of its Mather Point, looking down and with one foot dangling -- what is the possibility for a double bottom for the US$? Regular readers know well my thoughts re patterns that are obvious to all viewers, so the surprise -- nee, the shocker -- would be a sizable move in the opposite direction.

But what could cause such a turn? I look around, and the first item I see is a bottom building in the interest rate markets...

Rising rates, as the bullish patterns in the chart above indicate, equal declining bond prices; this is a lock-step relationship. And rising rates manifest as support, if not a bullish prop, for the US$.

Are there, perhaps, anecdotal items of proof of the possibility of this change? I begin with the charts that mirror the decline of the US$; that is, powerful rallies. Task accomplished, easily enough: commodities and cyclical stocks, the Dow Jones Industrials themselves included, have rallied powerfully the past several years. What happens to them in a sudden environment of rising rates and a rising US$? And do they not already give signs of exhaustion? Although I have been wrong heretofore with the impact a falling US$ would have on US markets, I suggest that, at minimum, our markets stare into the face, and possibly the teeth, of rocky times dead ahead.

It seems clear that the markets do not expect an environment of rising yields; no, investors both believe and invest today on the basis that the FED instead must loosen its stifling hold on 'high' rates to "save the domestic housing market," etc. The surprise could be that instead the markets force the FED's hand by transforming a flattish yield curve to one positively sloped -- with the FED right behind, tightening at the short end of the yield curve in response to market action at the long end. Should this occur suddenly, price dislocations elsewhere could occur with tandem suddenness. Ouch.

So, once again, I batten down the hatches. I note the confirmed double top in Under Armour/UA, with its hoped for temporary breach beneath oft-argued crucial support at $43. I note that Starbucks/SBUX breachs beneath its major trend line and from a confirmed double top; its prospects suddenly pointing toward next support at ~$22-20. There is no way to know its need to plumb such depths, but I note the large-ish gap until that next level of support, decide I have no need to be along for that possible ride, and sell. I do not rationalize my hopes and fears for specific positions, and build those hopes or fears into my determination to buy, sell, or hold. And yet I note Google/GOOG's breach beneath its trend line, but maintain my holdings; in fact, I will purchase soon more shares because the stock sells at a fundamentally inexpensive, even cheap, valuation. And so it goes. Welcome to the continuum.

One 'trick' of successful investing is to acknowledge the dynamics of both the markets -- oscillations of price within a trend of a given proportion, or periodicity -- and your level of tolerance for risk (measured by magnitude and amplitude; or, respectively, distance traversed from high to low and the distance between peaks or lows). I acknowledge my tolerance to be nigh on nil; instead, I acknowledge that I prefer to invest during periods of price momentum, and thus align my investment interests with market trends. Call it momentum investing, if you must, but I purchase unfailingly during doldrum-like periods of base building for my favored investments, so it is not truly momentum (-based) investing. The analytical tools I use break down the patterns to discern appropriate trends within stipulated time frames; this particular moment seems rife with price risk for many of my favored opportunities.

I want to be clear: at this moment, this entire post is mere speculation. A trend in motion tends to remain in motion... until it ends. And that is this post's purpose: to find signs of (possible) change in trends. Should a reversal of the obvious trends occur -- rates and the US$ rise rather than decline, the equity markets, especially its leadership themes the past several years, decline rather than rally further and higher, will it all be merely intra-trend volatility... or something worse? Only time will tell.

Questions? Comments?
-- David M Gordon / The Deipnosophist

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