There’s not much happening in global markets right now. Stocks are holding onto gains from the Trump rally nicely. They seem to be biding their time before the next move higher.
If you’re new to investing — or even if you’re not, actually — I’ll give you a little tip that will help to make sense of things when there’s seemingly not much going on.
That is, look at a chart!
It sounds simple, I know. But over the years I’ve found that people either love or hate charting as a form of analysis.
In many cases, those who love looking at charts do so because it’s a shortcut around the work of doing real analysis. They draw lines from one point to the next, and then draw lines from other points, crossing through the initial lines, until the chart is a fancy looking mess.
Or they see things in charts that they want to see, without doing the work to figure out whether it’s really useful information.
Then there are those who equate charting to astrology. They think it is a wacky theory that adds absolutely no value to the investing process. They are contemptuous of those who use it.
I don’t understand this mindset. Charting, used intelligently, gives proven results. Most of the traders interviewed by Jack Schwager in Market Wizards used charts to trade. Their returns made Warren Buffett’s performance look pedestrian.
There’s also a third way. This is the method I use, and I find it enormously beneficial in trying to analyse a range of different markets. I study the fundamentals AND look at a chart. I then combine the two disciplines to try and improve the odds of investing success.
The ‘improving the odds’ bit is important. There are no certainties in investing. That’s because success relies on favourable future outcomes, which you cannot possibly know.
The best you can do is to improve your odds. Combining fundamentals with charts is a great way to do this.
For example, say you think Trump is a disaster for the US. You think the recent Trump rally is ‘fake’ and it’s only a matter of time before the market gives up all the gains made since Trump won the election in November.
Well, it’s fine to think that, but you have to put it to the test. Are you thinking emotionally, or rationally?
Why the odds favour higher prices
This is where charts can help, especially when markets haven’t been doing too much for a while. So let’s have a look at the S&P 500, the most important stock index in the world.
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As you can see, over the past 12 months it’s moved steadily higher.
The yellow and blue lines in the chart are the 50 and 100 day moving averages. They smooth out daily price fluctuations and give you an idea of the market’s medium term trend.
This is pretty much all I use when looking at charts. I simply want to know whether the trend is up or down.
Because if a trend is moving in a certain direction, the odds favour a continuation of that trend. And if the fundamental backdrop supports the direction of the trend, that increases the odds even further.
So in the case of the S&P 500, you can see that the trend is favourable. Trump may be polarising, to say the least, but his policies should be supportive of growth.
Interest rates in the US are rising, but that’s because growth and inflation are picking up. And the Fed will err on the side of caution when raising rates anyway, so the odds of them stuffing up anytime soon are low. (This will change down the track after they’ve increased rates a few more times. They may raise rates a step too far.)
My conclusion then is that the market looks bullish. The charting picture supports the fundamental backdrop. The odds favour a continuation of the current trend. In other words, I think you’ll see new all-time highs for the S&P 500 in the weeks or months ahead.
If you interpret the fundamental data as bearish, the charts simply don’t support your view. You could be right of course, but the odds are simply against your view playing out right now.
What about the Aussie market?
Let’s have a look at the ASX 200…
Click to enlarge
As you can see, the index has been trending higher for the past 12 months. There have been corrections along the way, including fears over ‘Brexit’ and Trump winning the US election (albeit only very brief fears) but the trend has been higher.
Right now, we’re experiencing another correction. But the odds favour it being a correction within an upward trend.
Fundamentally, the Aussie economy isn’t all that strong. With household debt levels so high, you could argue that it’s actually quite fragile.
Profits recession to end
But corporate Australia has gone through something of a profits recession for the past few years. That’s because the commodity bust weighed on national income growth. With higher commodity prices now providing a boost to national income, there is an increased chance you’ll see better profit growth in the years ahead.
That’s what the rising stock market is communicating. Once again, you’re seeing an improving fundamental backdrop (higher commodity prices) in combination with a bullish charting picture. That tells you the odds favour higher prices this year.
And yesterday’s statement from the RBA governor, Phillip Lowe, suggests interest rates aren’t moving higher anytime soon. This should continue to support markets.
Importantly, Lowe said that a rising currency would ‘complicate’ matters…
‘The outlook continues to be supported by the low level of interest rates. Financial institutions remain in a position to lend. The depreciation of the exchange rate since 2013 has also assisted the economy in its transition following the mining investment boom. An appreciating exchange rate would complicate this adjustment.’
Increasing interest rates would put a rocket under the Aussie dollar, and the RBA doesn’t want that. So rates are on hold at a very low 1.5% for the time being. That’s good for asset prices.
To sum up then, that’s why I use charts when analysing markets or looking for stocks to buy. I don’t draw lines or focus on fancy indicators. I just look at the trend and make sure the fundamental factors support the story the chart is telling.
If something isn’t trending, then it suggests uncertainty and I’ll stay away.
But if something is trending higher and there’s a compelling fundamental story supporting the continuation of that trend, then often you have a very good opportunity on your hands.
This is how I found the biggest opportunity in Australian energy in years. It’s a long and fascinating story. I won’t go into it now. But you can click here to get the details.