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What ‘the inside of the stock market’ is telling us

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From Richard Smith, Founder, TradeStops:

Stan Druckenmiller is one of the best money managers of all time. He has a track record of better than 30% compound annual returns, over 30-plus years, with no losing years.

And Druckenmiller accomplished that track record while managing billions — which is harder than with smaller amounts — and made more money in down markets than up markets, which is harder still.

In a sit-down interview with Bloomberg, recorded a week before Christmas 2018, Druckenmiller explained one of his most important rules of thumb: Paying attention to the “inside of the stock market.”

Here is how Druckenmiller explained it in the Bloomberg interview:

If you look inside the stock market, the cyclical elements of the economy — particularly the front-end cyclicals — show a completely different picture than the defensive parts of the stock market.

… So that’s one of the things. The inside of the stock market — which is the best economist I know, and which I’ve used every cycle when I have invested — is saying there’s something not right here.

That may sound obvious now, but in the early weeks of December, it was prescient. So, what did Druckenmiller mean?

In the form of industries and sectors and bellwether companies, the stock market has multiple moving parts.

Some of those parts do better in “defensive” environments — when the economic outlook is negative or worsening — and others do better in healthy environments, when the economic outlook is positive.

When Druckenmiller says “the best economist I know” is the inside of the stock market, his point is that actual price movements are more useful than human predictions for gauging an economic outlook.

If the market is worried, that is a better guide than whether professional economists are worried — and vice versa if the market is upbeat.

Human economists and Wall Street analysts are notorious for falling behind the curve. They are too optimistic at the end of long bull runs, and too pessimistic at bear market bottoms.

Analyst predictions are also vulnerable to cognitive biases, like the desire to stick with herd consensus or please their clients with positive news.

The market itself, on the other hand, doesn’t care what anyone thinks. Price movement is a forecast mechanism that is too big to be manipulated.

A simple way to think about a market forecast — what the inside of the stock market is saying — is whether investors are moving towards cash or away from cash, as determined by what different parts of the market are doing.

At one end of the spectrum, “cash is king.” When investors move toward cash, the market is signaling economic pessimism. If a downturn or a decline in profits is coming, it’s better to have cash than investments that lose value.

At the other end of the spectrum, “cash is trash.” This happens when the desire to invest is high, the economic outlook is healthy, and asset prices are expected to rise.

Because markets and economies move in cycles, and economic conditions go from boom to bust and back again, the desire for cash swings like a pendulum over time. In boom times, cash is trash. In gloomy times, cash is king. Then the pendulum swings back again.

Heading into the new year, cash is in high demand. Over the past nine weeks, the Financial Times reports, U.S. money market funds saw $175 billion worth of inflows — a streak not seen since the 2008 financial crisis.

Four areas of the market that are extremely cash-like, besides money market funds, are U.S. treasuries, gold, gold stocks, and utility stocks.

  • U.S. treasuries are a deeply liquid “safe haven” asset. Investors buy them to reduce exposure to stocks, or if they fear hard times are coming. The value of USTs goes up as interest rates fall.
  • Gold is a kind of crisis insurance. It tends to go up when investors fear the outlook for paper currencies, or the possibility of central banks doing wild or dangerous things.
  • Gold stocks have long-term leverage to the price of gold, which makes them a kind of proxy for cash in scary times. Gold stocks did quite well in the 1930s and generate high returns in both inflationary and deflationary environments.
  • Utilities have a cash-like stream of payments because their main product — electricity to power homes and businesses — is always in steady demand.

All these areas of the market are doing well right now. In recent weeks IEF, the iShares 10-year treasury bond ETF, has been in a near-vertical rise.

At the same time, gold and gold stocks appear to have bottomed out, with gold stocks entering a new bull market trend (as we explained a few weeks ago). While December 2018 was a horrible month for most industries and sectors, it helped gold stocks extend their best rally in a decade or more.

Meanwhile utilities, while taking a hit in recent weeks, have held up far better than the rest of the market. XLU, the SPDR utilities ETF, hit all-time highs in December (while much of the market was tanking) and remains above its September 2018 lows, while many other areas of the market have given back all their 2018 gains and then some. As you can see, of the 11 S&P Sectors, Utilities is the only one that is not in the Stock State Indicator (SSI) Red Zone in the Ideas by TradeSmith Market Health tab.

This is the market telling us that “cash is king” right now — or is well on the way to being such.

The outperformance of cash-like safe haven assets is even easier to see when compared to front-end cyclical areas of the market like autos, transports and industrials.

For example, the First Trust Global Auto Index Fund, symbol CARZ, is an ETF focused on the big global auto makers — names like Toyota, Honda, Daimler, General Motors, Ford, BMW, and so on.

As you can see from the CARZ chart below, the market’s opinion of global autos has been negative for quite some time. The auto outlook is dark and getting darker, a sign of pessimism for global growth expectations.

Transports, industrials, and homebuilders are telling a similar story. The Dow Jones Transportation Average has declined sharply in recent weeks, with bellwethers like FedEx issuing profit warnings.

Price action in bellwether industrial names like Caterpillar (CAT) and Home Depot (HD) has the same message.

And none of this touches on what’s going on with Apple, China, and big tech in general — a discussion for another time (perhaps soon).

In sum, the “inside of the stock market” is the best economist Stanley Druckenmiller knows, and Druckenmiller is one of the best money managers of all time. Right now, the market is forecasting investor gloom and a transition towards cash and cash-like assets.

On the long side, assets like gold, gold stocks and utilities still top the general attractiveness list.

Richard

Crux noteMore than 25,000 investors are using TradeStops to help manage risk in their portfolios. Try it for yourself today with a one-month free trial.  


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Charts reveal buying opportunities in some Chinese stocks

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The stocks of a few top-notch Chinese companies may have already bottomed as a result of the U.S.-China trade dispute and could soon be buying opportunities for investors, a top chartist tells CNBC’s Jim Cramer.

Cramer, who has been steering investors away from Chinese stocks for the better part of the dispute, said he wouldn’t blame anyone for thinking Chinese investments were too risky, especially after China announced that its economy grew at the slowest pace in nearly three decades last year.

But when he checked in with technician Dan Fitzpatrick, the founder and president of StockMarketMentor.com and Cramer’s colleague at RealMoney.com, he started to see things a little differently.

“Fitzpatrick has a really interesting thesis: He thinks the current weakness is already priced into many of the largest, highest-profile Chinese stocks,” Cramer said on Tuesday. “Looking at the charts, he believes they’ve already bottomed [and] they’re not going to take that bottom out, which means dips, like the one we had today, … should be treated as buying opportunities.”

Cramer, host of “Mad Money,” explained this phenomenon: because the stock market is “a forecasting machine,” it tries to predict what could happen six to nine months from now. So, when China released its latest economic data, it should’ve already been baked into most stock prices.

“The market will almost always peak before the economy peaks,” Cramer said. “It will almost always bottom before the economy bottoms, and that’s what Fitzpatrick’s predicting with some of the better Chinese stocks.”

First, Fitzpatrick analyzed the daily stock chart of JD.com, a Chinese e-commerce company. His take? The stock just made a “totally buyable double bottom” pattern at $20 a share, and, so far, has held above that level, Cramer said.

Fitzpatrick also noted that JD.com’s stock managed to hold above its 50-day moving average after trading above it earlier in January, which signaled to him that JD.com could be ready to rally higher.

But the most important signal is coming from the stock’s moving average convergence-divergence indicator, or MACD, which detects changes in a stock’s path before they happen. That indicator has been soaring since September, which, coupled with the stock’s relative inaction, is usually a signal that a stock has “a lot more upside,” Cramer said.

“Still, Fitzpatrick says that the stock is kind of caught in the middle of no man’s land” between its $21 floor and its $24 ceiling, where it peaked earlier this month, Cramer said. “If the stock pulls back any lower, it could stay stuck down there for a while.”

However, if the stock can break through the $24 level, and Fitzpatrick believes it can, then it could climb as high as $29, the “Mad Money” host continued. Fitzpatrick would buy in as soon as it passes the key $24 threshold.

Also on the table for Fitzpatrick was the stock of YY, a Chinese entertainment streaming platform-meets-social network. Like JD.com, its stock formed a double bottom pattern and climbed above its 50-day moving average in recent months.

“Right now, YY’s trading at $68 and change. Fitzpatrick likes it as long as it holds above the 50-day moving average” of $65, Cramer said. “Now, the stock has a ceiling at about $70, but if it can break out above that, Fitzpatrick thinks it’s smooth sailing to $85.”

All in all, while Cramer has been wary of Chinese plays, it’s always worth examining “the other side of the trade,” he told investors.

“After today’s brutal, in-part-China-driven sell-off around the world, it’s worth considering whether some of these Chinese stocks may be in better shape than you’d expect,” the “Mad Money” host said. “The charts, as interpreted by Dan Fitzpatrick, suggest that the best-of-breed China internet [stocks] like YY and JD.com may have already bottomed, although Fitz says you should wait for more of a breakout before you start buying either stock.”

“I don’t know if he’s right, and I don’t recommend buying any Chinese stocks because of the trade turmoil,” Cramer continued. “But when just about everyone’s negative on a particular group, it’s always worth giving the other side of the trade some serious consideration.”



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Charts suggest lower volatility, higher stock prices ahead

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The market’s fear gauge is signaling that stocks will see less volatility and higher prices in the next few months, CNBC’s Jim Cramer said Tuesday after consulting with a top volatility chartist.

The fear gauge, also known as the CBOE Volatility Index or the VIX, tracks S&P 500 option prices to measure near-term expectations of volatility, or the chances that the stock market will endure dramatic swings in the near future. When the VIX rises, it tends to mean investors are growing concerned about the market and making bets to protect themselves.

But the VIX has been trading lower since it peaked in December amid a marketwide sell-off, suggesting that fears about the market are subsiding. To make sense of the action after the late-2018 fallout, Cramer asked technician Mark Sebastian, founder of OptionPit.com and resident “Mad Money” VIX expert, for his input.

Sebastian, who also works with Cramer at RealMoney.com, said that while the nature of the VIX has changed, it’s still helpful in predicting what’s next for the market. And, right now, it’s quite positive, he told the “Mad Money” host.

“Sebastian thinks it signals that this earnings season may be a bit of snoozer, with a bullish bias, as the market gradually pushes higher over the next few months,” Cramer said. “The Volatility Index may not be working exactly like it used to, [but that] doesn’t mean it’s useless, and based on the current action here, he thinks the stock market has more room to run.”

To reach this conclusion, Sebastian reviewed how the VIX acted over the course of 2018. Plotting it against the S&P 500, he noted that during the market’s breakdown in February and March, the VIX acted normally: surging when the S&P plunged, and making a lower high when the S&P dropped again, which signaled that the market had bottomed.

But in November, the VIX barely budged when the S&P got crushed, Sebastian said. Normally, that means that stocks are bottoming, but in December, the S&P collapsed again. The VIX only lifted in late December, after the S&P had fallen several hundred points, and didn’t even reach its January peak despite the fact that the entire market was selling off.

“Sebastian says the fourth-quarter decline was different from anything else we’ve seen in the last decade. Since 2008, when the stock market experienced a major sell-off, that’s always been accompanied by a huge spike in the VIX,” Cramer explained. “If you were only looking at the fear gauge, it seemed to be saying that the garden-variety sell-off at the beginning of last year was worse than the total meltdown at the end of last year.”

And, according to Sebastian’s analysis, the trading instruments that Cramer railed against in February — the ones that profit when the VIX does down — were behind the unusual action.

Specifically, securities like the VelocityShares Daily Inverse VIX Short-Term exchange-traded note, or the XIV, which imploded while the VIX stayed calm, “[represent] a sea change in how volatility is going to work going forward,” Cramer said.

“The crazy price action from a year ago left a bad taste in traders’ mouths,” he explained, adding that fewer money managers are likely to hedge their positions using VIX options after seeing 2018’s swings.

“In this new environment, hedge funds will no longer be racing to cover their short positions, which means that the VIX is probably going to signal that there’s less volatility going forward,” Cramer continued.

But that doesn’t mean that the VIX has become a less useful measure, Sebastian argued. The VIX’s tepid action in late December and early January was likely a precursor to the higher prices stocks are currently enjoying, he suggested.

So, as more money managers steer clear of risky VIX trading products and more still unwind their hedges, the fear gauge’s recent breather is signaling a peaceful few months ahead for stocks, Sebastian said.

Cramer’s take? “Even though I’m a little flummoxed that the VIX really didn’t work, I agree with Sebastian. I think we go higher.”

Questions for Cramer?
Call Cramer: 1-800-743-CNBC

Want to take a deep dive into Cramer’s world? Hit him up!
Mad Money TwitterJim Cramer TwitterFacebookInstagram

Questions, comments, suggestions for the “Mad Money” website? madcap@cnbc.com



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Medtronic CEO pushes back on criticisms it has a ‘spotty record’

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Medtronic CEO Omar Ishrak pushed back Tuesday on a Barclays research note that said the U.S. medical device maker took a “step back” following disappointing comments on the company’s outlook from Ishrak at the 2019 J.P. Morgan Healthcare Conference.

The medical device maker has “the strongest pipeline that we’ve ever had in this company,” Ishrak told CNBC’s Jim Cramer from the 37th Annual J.P. Morgan Healthcare Conference in San Francisco, California. “We innovate, we create new markets and we disrupt our own market,” he added. “We think these are game changers for health care.”

Shares of Medtronic sold off Monday, closing down 6.5 percent to $82.45 each after Ishrak said during an investor presentation that the company could expect sales to be at the mid-point of its full-year range of 5 percent to 5.5 percent. The company is experiencing softness in its top-selling cardiac and vascular unit, which makes defibrillators, pace-makers, heart valves, and stents.

Barclays analyst Kristen Stewart late Monday cut her price target on the stock to $104 from $113 and reiterated her overweight rating. In a note to clients, Stewart said she wasn’t surprised by the sharp stock reaction and characterized Ishrak’s comments as “cautious.”

“If it isn’t one thing, it seems to be another when it comes to Medtronic,” Stewart said. “Medtronic has had a somewhat spotty record when it comes to providing guidance and has been affected by a series of one-off events over the past year and a half.”

Ishrak said the note did not accurately reflect his comments.

Medtronic’s stock is down about 4 percent over the past 12 months and down 9 percent year to date.

Wall Street analysts have had some concerns regarding questions of the safety of paclitaxel, the drug used in commercially available drug-coated devices, which Medtronic make. Medtronic has said they are working with the U.S. Food and Drug Administration on that.

Additionally, Medtronic, along with the rest of the medical device industry, could face new regulations from the FDA, which seeks to change how the device manufacturers bring their products to the market.

Advanced Medical Technology Association, or AdvaMed, the industry’s lobbying group, has pushed back against the agency.

Despite weakness in the cardiac and vascular unit, Ishrak told CNBC the company is focusing on introducing technologies such as Micra, a new kind of pacemaker that is implanted directly into a patient’s heart and is less invasive than current methods.

Ishrak also touted the company’s $1.64 billion acquisition of Israel-based Mazor Robotics, a maker of guidance systems for spine and brain surgeries.



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