Above is a chart of the Russell 3000. This is an important index because it includes all the shares quoted on US stock markets that are considered suitable for institutional investment. Given this huge choice you can see why many investors don’t bother to look for opportunities outside the US, especially given the general trend towards higher prices.
The message in the chart is nothing new. Share prices are falling and the US, like other stock markets, is a dangerous place in which to invest at the moment. We also know what the problem is – a spectacular burst of inflation which is pushing short and long term interest rates higher across the developing world. Rising interest rates work by cutting demand which leads to a recession and rising unemployment which should take the heat out of inflation at which point the whole merry-go-round can start again.
So let’s start on the glossary which is not in any particular order.
Indices – these are used to take the temperature of stock markets so we know what is happening and whether the general trend is up or down. They are averages which may be weighted so $2 trillion plus Apple has a huge influence on what is happening or they may be capped so less influence for Apple or unweighted in which case Apple is just another share.
Bull markets – this is the name for periods when stock markets are generally trending higher. Happily this is most of the time as can be seen from the chart above.
Bear markets – these are the opposite and cover markets that are heading lower. There is an expression from the early days of stock markets that says ‘when the police raid a brothel they take all the girls. What this means is that when a bear is really underway all shares fall, good and bad. Bear markets can be short and sharp when they are called corrections or they can grind on for months, which is what we have now.
Charts – also known as technical analysis. The idea here is that studying the past price action of any investment instrument, shares, bonds, cryptos, currencies and so on, can give us insights into the likely future trend in prices. Without subscribing to many of the more arcane aspects of charting I would accept being described as a chartist. My rule is charts for timing, fundamentals for share selection and I give a lot of weight to charts in taking investment decisions.
Fundamentals – this covers everything that is not chart-related. Analysts spend weeks studying the fundamentals of companies, project sales and profits into the distant future and also try to value the business. Good luck with all that stuff. I am grateful to them for doing it but think it is mostly a waste of time. I use fundamentals to determine whether a share is growing strongly and has an exciting story. I can do this in a few minutes helped by the incredible availability of information on the Internet.
3G – I need to look at the fundamentals because I choose shares which are 3G as in great growth, great story, great chart. If a share is not 3G I am not interested. Subscribers often mention shares to me. I take a look, if it is not 3G, I am not interested.
Benchmark stocks – using the techniques described above I make lists of stocks which I like and from which I make recommendations. This list has become long over the years so I have pruned it back to a hard core of indices, cryptos, ETFs and shares which I called my benchmarks. I look through this at least at monthly intervals or even more frequently as a way of taking soundings on the health of the stock market. On 6 December 2021, before I had my benchmark list but something similar, I looked and was horrified to find how many shares were trending lower. I alerted subscribers and even suggested going 100 per cent liquid. I repeated this message on 6 January 2022 since when markets have been having a torrid time.
Indicators – indicators can be almost anything. I have ones that I use that work well for me. These include moving averages (see below), trend line breaks (see below), Coppock (see below) and the balance of shares and other financial instruments in my benchmark list looking positive v those looking negative. I also have what you could call bellwether stocks. OGIG, an ETF which holds a cross-section of exciting technology shares is a bellwether stock. Another one is Polar Capital Technology, an actively managed technology-focused investment trust, which is charted below. As you can see the shares had a spectacular bull market and are now falling after a rally attempt. The Coppock indicator for PCT is falling and has just become negative.
Coppock indicators – Coppock uses somewhat complicated mathematics to measure momentum for an index, a share, a cryptocurrency or anything where prices change. It only measures momentum so if the rise is losing momentum Coppock may turn down even while the shares or index is still rising. The creator, Edwin Coppock, believed that fund flows into institutions meant that the long term trend in shares was up. His indicator was designed to help institutions time their buying better by showing when the decline had been significant (as demonstrated by the indicator becoming negative) and when they should start buying again (shown by the indicator turning higher). It has an extraordinary record for changing direction close to the bottom of bear markets. I am using it for all sorts of things now and we will see how useful it can be.
Moving averages – this is a technique for smoothing out share price movements so that the daily noise is eliminated from the chart. A favourite way to use to moving averages is to use two, one shorter than the other. When the shorter term moving average crosses up through a rising longer term moving average that is a golden cross buy signal and vice versa for falling averages where the crossing point is known as a dead cross. There are millions of possibilities for which moving average to use depending on the time scale of your investment horizons. I am a long-term investor so I use weighted five and nine month moving averages which work for me and deliver timely signals.
Trend lines – trend lines become significant when they are broken. A broken uptrend line is bearish and vice versa for a broken down trend line. When you draw in trend lines on past share price movements the breakouts can look like a licence to print money but in real time they are harder to read and unreliable in the predictions they make. Is it a turning point or just a rally/ reaction against the main trend? It is hard to say so I use broken trend lines along with other indicators to help me to be more sure about what is happening.
Pattern analysis and consolidations – when I started charting it was all about patterns such as head and shoulders, triangles, flags, step patterns, lines and many more. I prefer to think of them all as consolidations, periods of sideways trading, where buyers and sellers are broadly in balance. Eventually we will have a chart breakout, which gave its name to one of my print publications, and that can often signal an important move.
Something new – something new is one of the most exciting stock market phenomena. The first Apple smart phone, iPhone 1, I suppose it was, was a phenomenal something new which drove a huge rise in the Apple share price. It was released in January 2007 when the share price was less than $3 against around $144 presently. Another gigantic something new was when Netflix decided to cannibalise its online DVD rental business by launching video streaming paid for by subscription. Since Netflix had to buy a ton of content to launch this business it initially forced the company into losses and the shares into a steep decline. But as investors realised the scale of the opportunity the shares took off. The rise was turbocharged by another key something new when Netflix began to create its own programming with House of Cards in February 2013. Coincidentally Netflix launched its streaming service in January 2007, the same year as the Apple iPhone, when the shares were $3.35 against $242 currently and a bull market high of $700. A combination of something new with a massive chart breakout is about as exciting as it gets in the stock market.
Chart breakdowns – I put this in so I could show you a terrifying chart breakdown which is happening right now. Below is illustrated a massive breakdown for an important stock, Advanced Micro Devices. It’s a head and shoulders top with one shoulder bigger than the other. If the shares fall by the depth of the pattern the price is going to halve from here. I would not want to be holding these shares. AMD is a semiconductor stock so this has implications for the whole sector and both Nvidia and Taiwan Semiconductor Manufacturing have weak charts. Intel, which used to be the doyen of the sector is in free fall.
Value investing – I mention this because it is not something I do. For me it is how long is a piece of string investing. The value of a stock depends on a whole load of things that are going to happen in the future. These include the macroeconomic environment, how fast the business grows, whether it develops or encounters exciting something news and a host of other unpredictable factors. I concentrate on what works for me and about which I can form a view. I select shares in companies which I believe are 3G and much of this will be obvious from even a brief study of the business. Once that is established I use charts to determine when to buy, when to add more and hopefully well into the future, when to sell.
Momentum investing – what I do is often described as momentum investing. I look for shares with strong positive momentum in the business and strong positive momentum in the share price. Such shares often do extremely well, especially if you can identify them at a relatively early stage. Another advantage is that when they lose momentum you sell. Typically the share price loses momentum before this is apparent in the business so I pay more attention to charts than fundamentals in deciding when to sell.
Crowd theory – this is another way of looking at momentum investing. The idea is that shares go up as more people become aware of the story and join the crowd of people investing in the business. Tesla (see chart below) has been an excellent example of this process in action. Back in 2010 electric cars were expensive, heavily reliant on subsidies to sell and charging points were few and far between. Against this background the crowd of people/ investors who believed in the company was small. Fast forward 12 years and there are electric cars including Teslas all over the place; they are much more affordable and, at least in big cities, there are loads of charging points. Next year the Tesla Model Y is expected to be the world’s best selling car. Not surprisingly the crowd of investors who follow and believe in the Tesla story has grown enormously driving a massive increase in the share price.
The three month rule – this is an idiosyncratic rule of mine. I have noticed that shares in strong trends, both up and down, tend to pause periodically to consolidate and very often these consolidations last for around three months. The latest consolidation and subsequent breakdown in the Shopify share price provides a good example. It may not always be so neat but I find it helpful.
Trading v long term investing – I am a long term investor but I am less convinced that forever investing is going to suit most people. It works for the people who own companies and can amass vast fortunes as result but it is just too hard for many investors given the extreme volatility of the high growth shares in which I am most interested. So if you buy shares on my recommendation you can expect, hopefully after a long holding period, that you will be told to sell. The timing of the sale will depend on my indicators for the individual share in question, for the indices and for my benchmarks as a group. I may also suggest going liquid as the safest strategy if my indicators are flashing red in a serious way. There are no magic bullets in the stock market, although Coppock comes close, so what ever we do needs to be applied with common sense.
Leverage – this is the process of buying shares with borrowed money. Many people dislike even the idea of doing this in which case don’t do it. You can still be very successful. Personally I do use leverage but it does mean you have to be very alert to trends because in the same way as leverage can enable you to ramp up the value of your portfolio very quickly gains can also evaporate with terrifying speed. It is certainly not for a buy and forget type of investor. If you want to describe my way of investing as gambling I accept that description.
Growth stocks – this is mostly self-explanatory but the metrics used to measure growth have changed in the era of the Internet and cloud computing. Many businesses now sell intellectual property in the form of software and services. Instead of being paid up front they receive a stream of income stretching years into the future. This means all the costs are upfront and revenue is deferred which in turn tends to lead to companies reporting losses. Since they are making losses anyhow companies have every incentive to focus on maximising growth by spending heavily on research and development and sales and marketing. The result is higher losses and faster growth.
How stocks are valued – this has changed over the years. Way back in the day the return (yield) on shares was compared with the yield on long term government bonds. Since shares were riskier assets they were expected to offer a higher yield but that was before inflation and before people realised that many businesses were growing in the post war world. First of all we had a reverse yield gap where the dividend yield on shares became less than the yield on bonds. Then a new valuation technique was developed called a price earnings ratio. A growth share might be priced at 20 times its latest earnings per share. Now, we have fast growing companies with no earnings so they are priced as a multiple of revenue and exciting stocks can be valued at 20 times revenue or even more which has helped valuations to climb higher on favoured growth shares.
I am preparing this glossary, which is by no means complete, for both subscribers and potential subscribers. I am sure many of you are already familiar with these terms but it never hurts to be reminded.
As I write we remain in a bear market. The current position is a mixture of failed rallies, consolidation and fresh breakdowns. There is nothing as yet to suggest that this bear market is over or has even run its full course..