Trade the Weak Against the Strong (XHB,QQQ)

We’re going to continue today with a theme that we’ve been pressing for some time now, but that still deserves some additional elaboration.

Believe it: It’s Different this Time

Wall Street is nothing if not skeptical. The best of the street’s traders and analysts are doubters nonpareil. Main Street also has its doubters. And it’s precisely that quality that’s traditionally made for a safer investment approach and higher returns over the long haul.

believe

 

This Missouri ‘show me’ attitude has saved many a market player a lot of money, because on Wall Street perhaps more than anywhere else, the need to kick the tires and look under the hood – or better yet, to get a forensic specialist to diagnose a potential purchase – is investment wisdom at its best. Yet even then, unforeseen problems can arise.

So when we say that we’re dealing today with an unprecedented situation in market history – when we claim that ‘this time it’s different’ and markets will actually grow to the sky – we appreciate that many a seasoned investor will look at us askance, and perhaps not a few will tell us to go jump in the Ganges.

And we understand that.

The only thing is, those folks are mistaken.

They’ll grow to the sky?

We take no joy in pointing out that this new reality exists. Indeed, we count ourselves amongst the most suspicious souls in the game – we believe almost nothing of what we read about stocks and markets, and that’s why we rely so heavily on the charts to get our investment bearings. The charts very rarely lie. But it’s also no lie to say that we’re living through a financial reality that’s so potentially ‘bullish’ (for lack of a better term) that betting against it will end up being costly in the extreme.

Consider the risks –

With a historically unprecedented mountain of liquidity in the system, two developments are all but certain –

• First, there will be soaring inflation at some point in the not too distant future, and
• It will be manifest to a very large degree in financial asset inflation: stocks, commodities, real estate, what-have-you.

Not participating in this liquidity-driven surge in the price of assets will simply put you behind the eight ball. As inflation picks up and erodes the value of the dollars you hold, poverty will descend like a marauder – but only on those who choose not to hold assets that appreciate with the coming rise in inflation. The need to possess stocks is simply paramount in a situation like that we see unfolding.

On the other hand…

bikini

 

 

That’s not a situation that can sustain itself forever. At some point, the jig will be up. The market will realize that the game has run its course, and like all other markets before it will begin to turn over and gather momentum to the downside.

The danger at that point becomes getting out of the game and converting all your overpriced financial assets into real stuff – goods that you actually require to live – before the entire house of cards collapses and there’s no value to be extricated from anything you once possessed.

Timing is the issue here – as it’s always been when the market gets overheated.

So how’s it different this time?

The essential difference today is that traditional fundamental and technical indicators will not be of much use as these ungodly surges of liquidity begin to circulate more rapidly within the system. With trillions of dollars available and markets on the rise, it won’t matter a whit what the S&P’s one year trailing P/E is, nor what RSI indicators are saying, or even if price action has gone parabolic.

We believe that P/E’s will ascend to unseen extremes, far above any historically known precedents, and overbought indications on the technical side will just continue into the hyper-overbought realm, much higher and for much longer than anyone expects.

And that will render these metrics all but useless.

survival

Our plan to discern a potential top in the market involves the use of a number of proprietary indicators centered around the dollar, whose strength, real and purported, we believe, will be the determining factor in deciding when the game is over. We’ll also continue to monitor a number of sentiment indicators built upon trade in both the broad market and the dollar to help us in that endeavor. And we’ll have more to say about those items as the time draws nearer.

In the meantime, bank on a bull market, friends, be invested, and pay close attention here.

This Week’s Move

When things get overdone either way, whether overbought or oversold, clear-eyed investors are given a gift.

And it’s with that principle in mind that we turn to this week’s trade, an effort that matches two distinct sectors of the market against one another – one overbought, the other… not so much.

We’ll start with a look at the NASDAQ Composite, as represented by the PowerShares QQQ Trust ETF (NASDAQ:QQQ), which has been on a winning streak unlike the rest of the major averages for the last thirty months.

Have a look first at the weekly chart –

qqq

Here we have a clear picture of strength for the better part of three years. But since the last highs in March were bested, we see both RSI and MACD indicators trending lower (in blue) – against the rise in price (in red). That’s divergence, and it indicates a slowing of buying momentum, despite the new highs set last week.

Before looking at the daily chart, we should mention that the NASDAQ is very close to matching its all-time highs set back in 2000 in the midst of the dot.com bubble. As the chart below shows, we’re only 12.5% from that important marker.


14years

And yet, as we’ll see from the daily chart, a rise to the old highs may not be imminent.

Have a look –

qqq2

The daily chart clearly shows an overbought move into the ethereal RSI 80+ realm (in blue), a development that we don’t believe will be looked upon kindly by the market gods (or Jimmy ‘The Shnook’ Trayder, either).

In addition, price is now cruising some 23% above the long term moving average (in yellow), a level that’s normally associated with engine stalls.

In short, there will likely be some selling here.

builders

We believe the homebuilders, represented by the SPDR S&P Homebuilders ETF (NYSE:XHB) will better hold their latest gains, simply because they haven’t come as fast or as furiously as the NASDAQ’s tech laden rise of late.

Here’s a chart of the two paired against each other since their last tops in March –|

xhbqqq

Housing’s had its breather.

It’s tech’s turn.

Wall Street Elite recommends the following trade for your consideration – buy the QQQ September 81.63 PUTs for $0.27 each and sell the XHB September 30 PUTs $0.25 for in equal numbers. Your total debit for the trade is $0.02 per pair traded.

The trade profits on any outperformance of XHB over QQQ in the next three months.

With kind regards,

Hugh L. O’Haynew, Senior Analyst, Normandy Research

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