A massive turning point is near – here’s how to trade it
Dominic Frisby Feb 06, 2013
We're approaching what is possibly a huge inflection point in some of the world’s most important stock markets.
The S&P 500, the FTSE 100, Germany's Dax - they're all closing in on their all-time highs.
We could see a massive, multi-year 'triple top', marking the end of a phenomenal run, which began in the aftermath of the stock market crash of 2008.
Or we could see a break-out to new highs, a move into 'uncharted territory'.
The decision-point could be as soon as a few days away…
These markets are at critical levels
Let me start by showing you some charts of the S&P 500, the FTSE 100, and the Dax over the 14 years since 1999. They clearly show the decision-point we're coming to.
In the interests of European union, let's start with the Dax. Below, I’ve drawn a red band across the top of the chart, marking the 2000 and 2007 highs and the wall of resistance they represent. The big issue is whether that band, just a few percentage points away, will prove to be a barrier - or whether this bull market will slice on through it.
Below, we see a similar pattern in our own FTSE 100, although we are slightly further off the all-time record. The FTSE is less than 10% off its all-time highs as the British economy teeters on the verge of triple-dip recession. There, if you still need it, is proof that economies and stock markets do not necessarily correlate.
I have also marked the bottom of the range - support - in green. You can see how well-defined it has been over the period.
Finally, there’s the S&P 500 (below). There is the same the red wall above. But we're just 65 points away from that 2007 all-time high of 1,576. Cripes, so bullish is sentiment, even Facebook (a Nasdaq stock, I know) is approaching its IPO price.
You can also see the defined range it has traded in over the last 14 years. Two huge bear markets - 2000-03 and 2007-09 - and two equally huge bull markets - 2003-07 and 2009-13. Is this bull market about to end? Are we on the brink of a new bear?
We could know very soon. The big red wall of resistance is perhaps just a few days away. So what – if anything – can we do with this information?
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What happens next?
“Let the trend be your friend - until it ends” is the maxim of the highly successful investment strategy known as trend-following. And what a trend it has been to ride - not just since the doldrums of last summer, but since the lows of 2009. This bull market really has climbed the proverbial wall of worry.
However, there is another, often equally successful method, which you might call 'range-trading'. This involves identifying ranges - support and resistance levels - and making your buy and sell decisions based on these. “The trend shall fail, range shall prevail”.
So who will be proved right? The trend-followers or the range-traders? The bulls or the bears? Are we headed higher or lower?
Nobody really knows of course - and anyone who tells you they do know is a dangerous person with whom to have money invested. It is possible, however, to make an educated guess, and manage your risk accordingly.
Starting with perhaps the commonly used investment decision maker of all - gut instinct - this doesn't 'feel' like a long-term top to me. There isn't talk of new paradigms. I'm not being given stock tips by shoe-shine boys. There isn't the sense that there are no more buyers still to come into this market – there are plenty still left on the sidelines.
So that’s my ‘gut’ feeling. What about the arguments for and against? I’m enjoying reading some strongly worded cases on both sides. In the one camp, we have people such as our own Tim Price (who is producing some excellent material at the moment). He says that this is “the most difficult economic environment he's ever known in which to invest”.
Mark Mahaffey, chief financial officer of Hinde Capital, endorses this view. He reckons “there has never been a riskier juncture in the history of investment at which to put money at work.” Mark, like Tim and I, recommends gold.
Over in the bull camp, we have the likes of the legendary hedge fund manager Kyle Bass, who recently declared on CNBC that he expects the S&P 500 to move higher - at least in nominal terms, if only because of the consequences of inflation. (Bass, I believe, also likes gold).
Meanwhile, JC Parets of Eagle Bay Capital notes on his blog, All Star Charts, that as the S&P 500 goes in January, so goes the year. “Since 1950,” he observes, “this indicator has an incredible 88.7% accuracy ratio.” The S&P 500 was up 5% in January, which bodes well for the rest of 2013.
They’re all good arguments. If markets sink from this obvious inflection point, the rationale of the bears will seem entirely obvious. And if you were long, you'll have wished you’d listened to them. But if the market rises - and you weren't on board - you'll have wished you listened to the likes of Parets.
How to trade this huge turning point
I’ll give you my tuppence worth – then suggest how you go about playing your own view.
Yes, there is too much debt. Economies are fragile. Growth is weak. But it's not like people don't know that. A lot of money has been created since the 2000 and 2007 highs (a lot of wealth has been destroyed too).
And perhaps more importantly, there are a lot of people - some of them managing large portfolios - who have missed this bull market and are waiting to get back in. They're behind their benchmark. Some of them have angry clients shouting at them: “How did you miss this?!”
Those clients are threatening redemptions. The ruthless guillotine of the City cull is hanging over. It doesn't matter what the underlying facts may or may not be, they have to get in and chase this market higher. It's what some call the 'pain trade' and it could easily push stock markets a lot higher.
Perhaps this is the beginning of a Ludwig von Mises, inflationary, crack-up boom when people suddenly become “aware of the fact that inflation is a deliberate policy and will go on endlessly. A breakdown occurs. The crack-up boom appears. Everybody is anxious to swap his money against 'real' goods, no matter whether he needs them or not, no matter how much money he has to pay for them”.
I don't think it is, however. My prediction is that we might make it to the highs, maybe even inch above them, then we slide back for a bit. But we'll break through them convincingly later in the year.
But I don’t have a crystal ball. This is a time to manage risk, as it really is an obvious inflection point. If you think the market's headed lower, and you're betting on that, put your stop somewhere just above those all-time highs.
If you think it's headed higher, do the opposite, stay long, but with a tight stop just below those all-time highs. That barrier of resistance could very easily soon become support.
• This article is taken from the free investment email Money Morning.
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