ZEGA Financials’ Back to the Future Moment with Dow Jones 24,000?

by | Dec 11, 2017 | Interest Rates, Technical Analysis

Someone recently asked me if I was surprised the Dow Jones reached 24,000 and if this marks the top in the market? My quick answer was no due to some old technical analysis of long term patterns in various markets. On the is this the top question? Well, we will know it once it happens. Regular readers know that the ZEGA message on equity ownership is to be long, but be hedged or buffered! The idea being why not participate in the upside but cap the downside just in case? This message hasn’t changed much over the years for our suite of hedged equity or buffered strategies.

In the earlier days of writing on the blog I used to file a few more pieces around technical analysis and the markets. Lately we’ve moved to more focus on the strategies, helping to illustrate the benefits and help answer questions while offering updates. But the person’s question reminded me almost three years ago I posted an article with Dow 24000 in the title based upon my technical analysis research utilizing long term charts.

Now to be clear, the reason for bringing up this interesting “Back to the Future” moment is not to claim victory or show how smart we are. The study of technical analysis is all about using the information to make reasonable predictions about what might happen. Some prove correct. Others never resolve themselves and prove to be false.

As you will see below it proved to be an interesting time where many long-term signals were being generated. Most of what we saw played out as the charts hinted. Instead the reason to bring this up today is simply to remind everyone that while the market is at all-time highs, the questions of are we at the top is the same thing people were asking back then. Rather than try and be right on when to buy or sell, the message instead is to be invested but have strategies which offer real downside protection should equities sell off materially.

Sometimes fear can be a detriment to entering a market. Yet if what you fear the most (the downside) can be muted, shouldn’t that fear be lessened? The original article from January 7th, 2015 can be found here.  I’ve posted a reprint below with some light corrections and re-posted the various graphics which had dropped off.

REPRINT FROM January 7th, 2015

Jan 7, 2015 – – Dow 24000? Plus, Top Long Term Technical Predictions for the Next Decade

By Derek Moore

Ok, so now that I have your attention, let’s take a long-term view of the equity markets, Dollar, Interest Rates, Crude Oil and more. Technicians like myself love to look at charts. We look at everything from 1-minute candlesticks on up to daily, weekly, and even monthly. Yet it is in the monthly charts we are able to step away from the noise and really zero on what’s happening on a long-term level. Unlike daily time periods, where each bar or candle represents a single days trading history, monthly bars represent an entire months’ worth of prices. This happens to be a very interesting time for long term technicals as all at once we seem to be witnessing breakouts and breakdowns.

Once of the things to understand is that there are shorter trends and patterns that emerge and can be traded. Furthermore, patterns guaranteed, rather looking at them shows what might happen and when we know they are wrong. Over the years I’ve called attention to a number of head and shoulder reversals tops that didn’t pan out. December of 2007’s worked, others didn’t and it’s knowing how to manage trades that really matters. With that said, let’s dig in to a couple of potential long-term trends.

US 10-Year Bond Yields

It seems like each year the Fed is perceived as more likely to raise rates. In fact, we saw rates move to around 3% in what was thought to be the beginning of a period of normalized interest rates. Yet if we look at the long term monthly chart of the US 10-Year, we can see that since 1985 rates have been in a nicely defined down trending channel.

What is interesting is that beginning with the lows in yields during the 2008 crisis, a secondary channel has arisen that is down sloping at a steeper rate. While many are calling for higher yields, the long-term primary and secondary trends tell a different story. So how can yields remain low? First, they can continue their technical downtrend. But from a fundamental basis, yields across Europe continue to be much less than the US despite higher unemployment and a less robust GDP. Currently the German 10-Year government bond was only yielding .45% while the US 10-Year a shade under 2%. So, if rates remain extremely low in Europe, plus a stronger US dollar, there seems to be room for more US Bond buying for higher yield, better economy, and holding assets in dollars which are rising in value currently. Because of that stronger dollar, which helps to keep inflation low, the Fed may have less pressure to actually aggressively raise rates.

So why the long view can be wrong on lower rates? First, for the very reason of the US economy coming out of recession and advancing, the Fed may see continued GDP growth (Latest was 5%) as an indication that our economy can handle beginning to normalize rates. Germany’s 10-Year has only 45 more basis points to reach a zero yield. The current spread between the two countries bonds is roughly 150 basis points so a 1% US-10 Year would imply negative rates for Germany at the current ratio. From a trading perspective, at some point if rates go to more extreme levels it almost presents a very low risk opportunity to get short treasuries. Remember Treasury bond prices rise when yields drop, so if rates move much lower, the risk on a short position theoretically is a floor of zero rates.

Technically a signal that the long-term trend has been broker would be first rates rising above the new secondary channel and then if it could rise above that powerful 30 year down trending channel.

Dow 24000

One of the patterns we’ve witnessed over many years is a broadening or megaphone technical formation. This happens when you have a series of higher highs and lower lows. Technicians will point out that it doesn’t happen that often. In fact, as we see above, looking at a 100-year chart of the Dow Jones Average, besides the current pattern we must go back to the 1965-1985 period to find one. Sure, there have been plenty on lower time frames, but since this is a long-term discussion notice that the next one started around 1997 to our current market.

Megaphone patters are significant because when price break out one way or the other, we can take the low in the pattern against the high, calculate the distance and then from the point at which price breaks out draw a target. As we see below, we recently saw a break above the top of the broadening formation.

If we take the distance between those two points, we roughly have a distance of about 8000 Dow points. Since the breakout happened at the 16,000 level that would put a target out to Dow 24,000. Now before you go out and load up on out of the money calls, understand technicals can give us targets, but also provide an area where we know our idea has failed. One thing I’ll be watching is to see if price stays above the top pattern line. If it were to test it and not hold thus retreating back into the pattern, we might see sideways or a retest of the lower area. Why this is significant is that many expected prices to bounce once again off the top trend line before moving lower. Later I’ll bring into our discussion a monthly chart of the S&P 500 Index. As I’ll point out on the chart, October of 1987 is barely recognizable. So, understand that long trends have gyrations and pullbacks.

Nasdaq Breaking Above March 2000 Highs?

So why can’t the Dow continue to march towards 24,000 unabated? For one the Nasdaq or more precisely the Nasdaq 100 Index Symbol $NDX has yet to prove it can break through a strong double top.

Above we see the unbelievable chart of the NDX including the run up to its all-time 200 high. Since then we have seen price slowly produce a series of higher lows, but we are now at an inflection point right up against the old monthly closing highs. Later when we talk about Crude Oil I’ll mention the problem with extreme acceleration in price up or down. The Nasdaq certainly experienced that but this march higher has been much more orderly. If the NDX 100 can break above the old highs, old resistance would become new support. Often markets (Dow, S&P, etc.) can leading or lagging each other. Making new highs would help validate the other Indexes.

S&P 500 Index 12 Month Moving Average

Above we see a monthly chart of the S&P 500 Index from 1964 through present. Like the Dow back in 1965, the S&P also saw a megaphone pattern. Although here it failed to resolve itself and found support mid-range creating an ascending channel borrowing the old megaphone top line. When it broke out around 1983, it retested and fell back into the old area before going on an unbelievable bull run. Notice how unless it was pointed out you might have missed the October 1987 crash which saw the market lose the highest percentage ever in one day. This is further backing as to why monthly charts show the big picture that contain many significant shorter-term trends.

One of the interesting things to look at is the moving average line in red. This is a simple 12 period moving average so since we are on monthly time frame, it represents an average of the last 12 months. Moving averages tend to work best during trending periods. As we can see during the sideways action of 64’ to 83’, traders might have gotten whipsawed using it. Yet what is interesting is that from the pattern breakout in 1983 all the way to 2000 prices essentially closed each month higher than the moving average line. Plus, the line continued to slope upward. I point this out because even looking at the period starting in 2000 to the present, being long when price was above the 12-period moving average seemed to work well. Currently prices are still above the MA and it is pointed up.

So why won’t these breakouts work long term? Off course we could say enter random geo-political event here. If inflation came back. If Europe truly slides into a recession along with China dragging the US and the world economy down. Do you need to try and be right on this? Remember our core philosophy of Buy and Hedge. For our clients we are getting long positions in the market with a hedge in place to put a floor in their portfolios. And if the market should sell off we can monetize (i.e. buy more shares at lower prices) by cashing in the profitable hedges.

US Dollar Moving Higher Still?

The US Dollar after making multi year lows against major currencies has seen a resurgence of late. Above we see how after a consolidation triangle or wedge a breakout to the upside. If you remember from earlier, taking the distance between the bottom and top of the range we have a target of somewhere just below 110 on the Dollar Index. Part of the fundamental reasons might include the idea that the US is more likely to raise rates and currencies with higher interest rates relative to one another tend to see inflows. With US Treasuries currently experiencing higher yields than Europe it would stand to reason money flowing to grab higher yields at perceived lesser risk. If the narrative plays out we might expect the dollar to gain, especially if the Fed starts to raise rates. When we look at the chart of the Euro/USD below, we can see another inflection point that seems to point to a possibility of the exchange rate getting to parity or 1 Dollar per 1 Euro. Targets even suggest potential for the Euro to move below parity to the old support area of .85 cents.

Crude Oil

Finally, Crude oil. I’m certainly not early on this one but if you remember we did point out the continued downtrend and if you wanting to catch a falling knife a potential trade. Since then oil is down another 15 to 20 points. We can see from the monthly chart that crude saw an uptrend from its 2009 $40 bottom. Yet as the trend matured we saw price compress into a triangle represented by lower highs and higher lows. The exact opposite of our broadening megaphone pattern earlier. Measuring out the target we do see potential for based on the technicals for a $35-$40 support area. This would line up with the 2009 lows. One thing with oil though, as we saw in the 2007-2008 run up and subsequent drop during the financial crisis, extreme moves seem to lend themselves to snapbacks. Will Oil find strong support at $40? Better question might be, if it does get there, then what?

The Long Market Hedged Trade for the Next Decade

So, the question comes up, if you want to invest in the broad US markets but are worried about weathering shorter term pullbacks, how do you do it? Next week I’ll follow up with what might be the best way to participate in the market using a hedged equity position and options. Plus, I’ll delve into a leveraged version with that is still hedged against black swan events.



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