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Shares rising, shares falling (most of them) and shares on the turn (Chinese)

June 30, 2022

In my world there are three kinds of shares, shares which are rising, shares which are falling and shares which are changing direction. This is why when I go through my tables of shares and ETFs I get a picture of what is happening with the overall stock market.

The message at the moment is very clear. In the sector I follow, high quality growth shares, the overwhelming majority of shares are falling. In cases where share prices are rising they are reacting to heavy falls and there is no sign of my key indicators (trend line breaks, moving averages, Coppock, 10-day rule) changing direction. They will eventually but currently this bear market is in full spate and the appropriate stance for investors is extreme caution.

Investors are worried that surging inflation will lead to higher interest rates and will ultimately only be tamed by a recession. It is also the case that once a bear market starts it needs to run its course with all the loose holders forced to sell. It may even end as bear markets often do with major bankruptcies and that moment of capitulation when the last bullish holdouts finally decide to sell.

There are no rising shares. I have not been able to find any except in areas I don’t really follow like energy and materials which are part of the inflationary pressures. There is a group of shares which appear to be changing direction and that is the Chinese shares about which I have been writing in recent issues. There is enough evidence of a turning point to warrant taking some positions bearing in mind that the Coppock indicators have flattened out but not yet turned higher.

These Chinese shares are not the dodgy Shanghai-quoted variety. They are all quoted on Nasdaq and or in Hong Kong and typically priced in US$. They are all exciting businesses which are doing well in a tough period and should do very well as and when we see a strong global recovery. Meanwhile China and Hong Kong do not seem to be suffering the same inflationary interest pressures being felt in the West.

If I go through my tables, which I do on a monthly basis I make lists of shares looking positive, shares looking negative and shares that seem to be changing direction. This in turn helps me take a view on prospects for the overall stock market. In 6 December 2021 I was so alarmed by the high proportion of shares looking negative that I sent out my ‘Time to circle the wagons’ alert advising subscribers to sell and even consider going fully liquid.

As usual I did this myself and then was tempted back in by stunning fundamentals which (a) was not a good idea and (b) has left me somewhat disillusioned with fundamentals as a guide to when to buy and sell shares. They may be great for share selection but after that, as far as I am concerned, it is all about charts.

You could visualise all this as a system of flashing lights like the cockpit of a plane. When I look at the stock market at the moment I see loads of lights flashing red, none flashing green, and some lights flickering between red and green suggesting they could be changing direction.

Does it ever make sense to buy when so many lights are flashing red? It could do because unlike with aircraft in real life we know that this plane is not going to crash and will eventually get airborne again if that does not scramble the metaphor too much. So we could take the view that if there is some sort of apocalyptic down day it might make sense to buy something, say my favoured QQQ3 ETF. This is a strategy I will bear in mind. It worked very well in March 2020 when the enormity of Covid became apparent and I suggested buying QQQ3 on the day the market hit bottom.

Strategy

This is all becoming a little repetitive about my indicators but I still think it is a useful exercise to be as clear as possible about the message the stock market is giving us and the way we interpret that message. In part this involves a change of attitude on my part. Although I use them and write about them all the time I have always been someone sceptical of using charts to predict what the market is going to do.

However I have been influenced by cryptocurrencies where there are no fundamentals. It is all about charts and they have worked very well in calling the big moves, up and down. I have also concluded that the kind of shares I like, high growth so with much of their value in the future, are so vulnerable to changes in discount rates (interest rates) and sentiment that they behave very like bitcoin with huge swings up and down. Finally I have decided that bitcoin itself behaves very like a high valuation growth share so cryptos move in line with the Nasdaq 100.

The end result of this is that I have adjusted my approach to shares to put much more emphasis on reading the price action. I use the usual mixture of techniques, fundamentals, charts, common sense and long experience to choose shares which are 3G and in which I want to invest. But once that initial choice is made I then rely heavily on charts to decide when to buy and sell.

As noted above and in many recent alerts growth shares generally and in US markets particularly are in a full blown bear market. This will bottom out when gloom is thickest and we should then start to see my indicators giving buy signals. Some of my indicators, Coppock especially are time sensitive so the more time that passes the more likely it is that they will start to turn higher. Coppock moves in long swings which works best when the stock market does the same as does indeed appear to be happening.

This could partly reflect the increasing use of leverage. I use leverage to create additional equity in rising markets and then use this additional equity to add to my holdings and buy into other shares giving buy signals. Imagine if there are millions of people doing the same thing. This will give stock markets a tendency to rise strongly until something (rising inflation and higher interest rates) triggers a change in direction and then fall as hard as they rose as all those leveraged investors are forced to sell.

The process can be further magnified by the fund management industry. In recent years loads of specialist ETFs have been created to capitalise on this momentum in the stock market. Inevitably they tend to invest in the same shares creating a feeding frenzy so that many ETFs have similar holdings. Once the market turns against them investors who have bought into these ETFs sell putting pressure on the managers to do the same.

The result is that there are many accelerators built into the stock market which leads to the big swings which help my indicators work so effectively.

A wealthy man called Calouste Gulbenkian once boasted back in the day that he had bought a Rolls-Royce which could turned on a sixpence, adding, whatever a sixpence is. A sixpence for those too young to remember was a tiny silver coin worth, duh, six pence, at a time when there were 240p to the pound in those long dead innocent days when I myself was young.

This market also appears to have turned on a sixpence especially for shares in many of the fastest growing businesses like Shopify. The shares peaked at $176 in November 2021, adjusted for a 10:1 share split, and seven months later the price is $33.05. As a result of this huge fall the shares are much more cautiously valued on a multiple of revenue of maybe seven times versus 40-50 times but there is still little support from profits with net income expected to be negative through to calendar 2024.

Fundamentals can be used to rationalise anything which is another attraction of charts. All the signs are that Shopify remains an exciting, fast-growing business. Below are a couple of quotes from their Q1 2022 results.

Even with the current resurgence in offline retail, we still believe that e-commerce will continue to grow and take share of overall retail over the long term, and we are well-positioned here with our online commerce GMV posting a 51% compound annual growth rate since the start of the pandemic in Q1 2020, faster than overall e-commerce over the same period, and we took share this past quarter as well. Our overall GMV, including offline, grew even faster at a 57% compound annual growth rate since Q1 2020, demonstrating that the opportunity for Shopify is beyond just online. It’s to be the commerce platform of choice in any environment and on any surface. The result of these past two years is that our trust battery with merchants is fully charged.

Q1, 2022 results, 6 May 2022

And as Fortune 500 companies move fast to keep their brands top of mind, we look forward to working with systems integrators to bring more of the world’s best loved brands onto Shopify Plus. The energy at Shopify Plus right now is terrific as the team finished Q1 with their best month ever, closing 20% more deals in March than ever before. The variety of merchants and ways they’re using Shopify Plus continued to grow with new launches in the quarter spanning well-known brands in food, footwear, art supplies, cosmetics athletic gear, tech companies and video games, including the legendary Miami Beach restaurant, Joe’s Stone Crab; Havaianas, Mexico; Crayola; Fiora Cosmetics; Bridgestone Cycle; TRX Training; Figma; and Call of Duty. The Internet’s favorite influencer, MrBeast, launched his own chocolate brand on Shopify Plus this past quarter, and the NBA followed the lead of the Chicago Bulls, who launched the sale of NFTs last summer with their own all-star NFT store on Shopify in the quarter.

Q1, 2022 results, 6 May 2022

The ingredients are there to support a strong resumption of the bull market but the dangers of jumping the gun are only too evident from what has happened over the last seven months. The sharks I described as circling under the water in December 2021 are still there.

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