Thursday, January 19, 2017

Dow 20,000: A new beginning…or the beginning of the end?

After touching the benchmark 20,000 level last month, the Dow Jones Industrial Average has spent the last five weeks in a tight, narrow trading range just under this level.  Famed trader Jesse Livermore theorized in his pseudonymous book, Reminiscences of a Stock Operator, that stocks are attracted to major round number levels.  In the case of the Dow, the 20,000 level has generated more press and speculation among investors than any number since the formerly mythical 10,000 level was crossed in 1999.  Clearly Dow 20,000 carries a tremendous psychological significance, even if it’s a simple case of self-fulfilling prophecy. 

While the technical significance of Dow 20,000 can be endlessly debated, the action of the Industrials in the weeks following the first test of this level is of more immediate concern.  To wit, does the action of the last several weeks represent a normal consolidation (i.e. a “pause that refreshes”), or is it indicative of distribution (i.e. informed selling)?  The NYSE tape doesn’t suggest distribution since the new 52-week high-low differential has been mostly healthy in the last few weeks while market breadth has also been confirming, and in some cases leading, the advance.

It’s possible, however, that the extended effort to push above Dow 20,000 could be the prelude to a distribution phase.  In an earlier commentary we discussed the distinct possibility – based on the “echo” of the 10-year cycle – that the coming months could witness a blow-off interim top, followed by significant decline at some point later in the year.  Historically such declines have occurred in the late summer/early fall months, particularly in the seventh year of the decennial rhythm. 

A run-up above the Dow 20,000 level, should it occur, would undoubtedly generate lots of enthusiasm among the hold-outs in the retail investor camp.  There’s still a huge amount of money on the sidelines right now with small investors still skittish about buying stocks at current valuations.  But greed is a persuasive argument, and if the Dow breaks out decisively above 20,000 in the coming weeks it would serve as a magnet for sidelined money.  One thing that investors can’t stand more than anything else is watching an historic rally while they’re sitting in cash and not participating.  A breakout above 20,000 would likely trigger the primal instincts of these non-participants. 

Although the 20,000 level carries great psychological significance its technical significance hasn’t yet been cemented.  In order for 20,000 to become technically significant it must be established as a “seldom crossed line.”  A seldom crossed line is a concept developed by the late market technician P.Q. Wall.  Wall emphasized that when an individual stock or market index crossed an important price level only a few times in its history, the level takes on added significance as both a support and resistance level.  He wrote:

“If cycles exist at all there must by that very fact be equidistant lines of price on a vertical scale that rise as more energy enters the market.  These should be seldom crossed lines between which price tends to cluster about equilibrium points that mathematicians would call strange attractors but that we call magnetic midpoints….Electrons in an atom rise and fall in just such stair steps.”

Take for example the chart of the Dow Industrials shown below.  While many investors touted Dow 10,000 as a critical level back in the late ‘90s and early 2000s, that particular level was actually crossed many times on both the upside and the downside.  By Wall’s reckoning, this invalidated the 10,000 level as having major significance as a long-term support or resistance level – as history subsequently proved. 

Wall believed that when a stock’s price encountered resistance at a key level without breaking above it then finally succeeded in breaking out the rally that followed would be noteworthy.  For the Dow, the closest thing to a seldom crossed line is the 14,000 level.  This was established as a pivotal level when the Dow broke out above it in 2013, then proceeded to rocket all the way to the 18,000 level before wavering.  In the future, any major decline that tests 14,000 is likely to be turned back due to the established technical significance of this level.

As for Dow 20,000 you can see in the following snapshot of the last three months’ worth of trading action that the level in question hasn’t been penetrated on the upside yet.  This is an important first step toward the establishment of a seldom crossed line.  The Dow has yet to lay claim to this important designation of the 20,000 level, however.  The key ingredient here is time and the reaction of the Dow’s price line to this pivotal level in the coming days.

If Dow 20,000 turns out to be a seldom crossed line then the next attempt at breaking above this level should see an explosive rally with no immediate reversal.  In other words, it should cross above 20,000 only once and not look back for a while.  Accordingly, the next few weeks should be quite interesting and potentially historic depending on how the market behaves once 20,000 is finally crossed.

Thursday, January 12, 2017

Biggest challenge of 2017 directly ahead for gold, stocks

If you thought the pace of the head-spinning political events of the last two months couldn’t get any faster, think again.  One of the most critical decisions of President-Elect Trump’s reign will soon be decided.  The final verdict will have a direct impact on the direction of stocks, gold, and the economy in the months to come.

The decision in question is the Congressional challenge being made against the Affordable Care Act (ACA), also known as Obamacare.  Specifically, the requirement that individual Americans carry health insurance or else pay a stiff financial penalty is being challenged.  Earlier this week, Trump directed the Republican-led Congress to begin efforts at repealing and replacing the health care law “very quickly.”

The mainstream news media is sparing no expense in its efforts at turning public sentiment against a repeal of the healthcare law.  CNBC reports that “the number of people who owed Obamacare fines last year dropped by about 20 percent, while the number of Americans who benefited from financial aid for Obamacare plans grew to more than 5 million.”  The latest data was culled from 2015 tax returns to the Internal Revenue Service. 

IRS Commissioner John Koskinen said the number of people receiving Obamacare subsidies was up from 3 million in 2014.  For that year, customers got more than $10 billion in tax credits, with an average subsidy of $3,430 annually, according to the IRS.  Obamacare subsidies are available to wage earners with low and moderate incomes.  People who earn less money get more in assistance than higher earners.

Koskinen wrote that about 6.5 million taxpayers last tax season reported owing a total of $3 billion in such tax penalties for failing to have coverage in 2015.  In contrast, about 8 million people owed an Obamacare fine for lack of coverage in 2014.  Fines related to lack of coverage in 2014 totaled $1.6 billion.

CNBC reported that some 12.7 million people claimed one or more exemptions from the ACA-coverage mandate when they filed their taxes last year.  “The exemptions are wide ranging and can include having very low income, being incarcerated or having a close family member die recently,” according to CNBC. 

While pro-Obamacare media outlets such as CNBC are touting this news as confirmation that the ACA is “working,” the gorilla in the room is conveniently ignored.  The reason for the decline in Obamacare fines last year is that millions of Americans experienced a significant drop in income, which ironically is a direct result of the economic damage inflicted on businesses by the financial strictures of the ACA. 

CNBC also reported that the Republican-led Congress last week began taking steps toward repealing key parts of the ACA, which include the funding of premium subsidies and the individual mandate.  For the middle class’s economic sake, let’s hope the effort is successful.

You may be asking what all of this has to do with the price of gold or the stock market.  The answer is “everything!”  Repealing the individual mandate would serve as a huge catalyst for the U.S. economy and financial market.  It would lift a grievous burden from the shoulders of working-class Americans and would serve as a stimulus to consumer spending.  Economics 101 establishes that when wage earners are allowed to keep more of their income, they’re less likely to think twice about spending and investing it. 

One of the big reasons for the Nowhere-ville sideways trend in stock prices in the last couple of years is because people have been forced to think twice before spending or allocating money into investments due to the constraints of the ACA.  Pollsters have consistently underestimated the number of healthy individuals who choose not to carry expensive health insurance because they don’t consumer healthcare services.  Now those healthy individuals are being punished for their lifestyle choices by being forced to pay upwards of $1,000 per year in the Obamacare tax simply because they choose not to be insured.  This is an assault on personal liberty and common sense, and it has created a massive obstacle to full economic recovery. 

What can investors expect if the Obamacare tax penalty is soon repealed?  First, there will be an immediate uptick in consumer spending and overall economic activity.  Americans are always looking for an excuse to spend, and if they’re provided with what amounts to a massive tax cut they’ll express their relief by purchasing the items on their wish list that they’ve held off on buying due to personal budget constraints.  Businesses, moreover, will begin to pick up the pace of hiring since the healthcare mandate is no longer acting to suppress business investment spending.

A repeal of the ACA’s individual mandate would also revive the fortunes of publicly traded companies which serve the middle class.  Many of these companies’ stocks are components in our Middle Class Index (below).  The Index has been languishing for the last two years, but I’d venture that an upside breakout from the lateral trading range would shortly follow an Obamacare repeal.

As for gold, a repeal of the individual mandate would also likely have far-reaching consequences.  Gold’s fortunes would be helped, ironically, by success in getting the Obamacare tax removed.  While gold is primarily a safe-haven asset which feeds off investors’ concerns about the economic and political outlook, gold’s moves over the last two years have been closely correlated to the direction of the Middle Class Index.  As the fortunes of companies which serve middle class consumers have risen, so has gold’s price.  Conversely, last year’s major peak and subsequent decline in the Index has coincided with the July 2016 peak in the gold price and corresponding mini-collapse.

Wednesday, January 11, 2017

2017: Year of extremes

Now that another New Year is upon us, it’s time to reflect on what the coming months might unfold.  Normally when market analysts try their hand at predicting the year ahead it involves either wild guessing or linear extrapolation based on prevailing trends.  I tend to eschew both methods and instead focus on comparing past events in comparable time frames.  This method is based on something known as Kress cycle “echo” analysis and was pioneered by my late mentor, Samuel J. Kress. 

The year 2016 was filled with ups and downs, but was mainly a torpid year with stock prices stuck in a dull trading range for much of the spring and summer.  It continued a theme of directionless and no progress from the prior year, which, combined with the after-effects of the preceding slow-growth years, culminated in a disaffected mindset on the part of the masses.  The result was clearly seen in the outcome of the 2016 U.S. presidential election.

One of the most reliable of the long-term market rhythms (or “echoes”) is the 10-year (decennial) pattern.  This is often erroneously referred to as a “cycle” despite not fitting the technical definition of one.  The 10-year rhythm was famously expounded by the late market analyst Edson Gould and by Edgar Lawrence Smith in his book, Tides in the Affairs of Men.

The seventh year of the decade tends to be tempestuous and often sees extraordinary volatility.  It’s a year filled with extreme ups and downs and not uncommonly witnesses both a major high and a major low within the year.  In recent decades, the seventh year has witnessed the market making impressive strides, yet not without its share of turmoil.  Crashes, mini-crashes and panics are quite common in the seventh year (e.g. September 1987, October 1997, February/August 2007).  It will do us well to keep this in remembrance as we enter what promises to be a year filled with tremendous opportunity for making money in the stock market – in both directions. 

For 2017, the 10-year rhythm equates to 2007.  As you recall, 2007 was a momentous year characterized at once by great volatility alternating between great fear and euphoria.  It was the year that saw the last major stock market top and also the onset of the credit tsunami which overwhelmed the market the following year.  If the decennial pattern holds true, 2017 should witness both a meaningful rally to new all-time highs as well as a decline of potentially major proportions later in the year.  In short, it could turn out to be a big year for the bulls as well as the bears.

Now what about the economy in the coming year?  Year 2016 ended on a positive note, with the last meaningful economic news in late December being the revelation that U.S. consumer confidence had hit a 15-year high.  The Consumer Confidence Index hit 113.7 in December, exceeding economists’ expectations of a 109 reading.  The reading was the highest since August 2001.  Rising sentiment among consumers implies an optimistic economic outlook in the wake of Donald Trump’s election win.  The following graph is courtesy of the Trading Economics website (

For many in the middle class, Trump’s win has provided a reason for genuine hope for the first time in years.  Whether this hope will ever be fulfilled is a matter for conjecture.  What’s important from a market perspective is how consumers and investors respond to that hope.  To that end the appropriate question to ask is, “Will 2017 be the year that retail investors finally return from the sidelines?” 

For the year-seven decennial pattern to repeat, as it has in the three prior decades there must be not only a continuation of rising consumer confidence, but an acceleration in investor optimism as well.  To this end, it would seem necessary that small investors return from the sidelines and put their money back into the stock market.  After years of being stuck in the bomb shelter of low-yielding bonds, this important group of participants is no doubt feeling the urge to grow their money. 

To that end, the stock market is beckoning to them – especially with so many major indices at or near all-time highs.  The fact that the man who they believe represents their interests as an economic class will be in the White House will serve to stimulate their confidence in the economic outlook.  History shows that when consumers feel good about their intermediate-term economic prospects they are more likely to invest in stocks. 

Here is what investor sentiment currently looks like according to the Rydex Ratio of investor sentiment.  We should ideally see a major spike higher in this ratio sometime this year, ideally by late summer, to let us know that the historical pattern for Year Seven is on track for being repeated.

Whether or not 2017 will prove to be the exception to the “rules” of the decennial “echo” established in the prior decades remains to be seen.  We are certainly living in exceptional times, so it’s possible that 2017 will in effect throw the historical playbook out the window.  But as the last several years have resonated to the tune of the Kress cycle echoes to some degree or other, I have to assume that there will be at least some validity to the decennial rhythm for 2017.  Remember, while history doesn’t always repeat it does usually rhyme.