I’m not one for making predictions. But as we reach the halfway point of the calendar year (and the end of the financial year) I thought it would be fun to make some guesses about how the rest of the year will play out.
To do so I need to show you a few charts. Chart watching is an invaluable analytical tool. It’s all well and good to study a company’s ‘fundamentals’ — it’s income statement and balance sheet, valuation metrics and its business model — but this only gives you half the picture.
The ‘fundamentals’ consist of numbers. Numbers are notoriously unemotional. The just give you a surface view. They don’t give you an insight into the emotions — the fear and greed — flowing strongly under the surface.
That’s where the charts come in. Charts reflect historical price performance. Sometimes prices are a good representation of the fundamentals. Sometimes they’re not. As you know, stocks can be overvalued or undervalued for extended periods of time.
Prices (and therefore charts) reflect the emotions of investing. And as far as I’m concerned, the best way not to get caught up in emotion is to recognise it and guard against it.
There is a reason that charts display the same patterns over and over again. It’s because they are representative of human emotions, and as you know, human emotion does not change. Fear and greed are ever present in the stock market.
With this in mind, let’s pick up where we left off yesterday, and take a look at gold. Gold is perhaps one of the most emotional asset classes out there. That’s because for many, gold is a representation of their moral outlook on life. It is also a representation of safety and security, one of humanity’s basic needs.
So let’s have a look at the charts of some gold stock indices, starting with the large-cap gold stock index, the HUI.
As you can see, after peaking mid-way through 2016, gold stocks went through a sharp correction. They rallied at the start of the year, but the chart reflects a sideways to downward trend. This tells you there isn’t a lot of investor interest right now.
It’s not exactly reflecting a picture of fear. Rather it’s one of disinterest. Which makes sense. As long as the Federal Reserve has the intention of raising interest rates, and while inflation remains low, there isn’t a lot of reason to own gold or gold stocks right now.
The picture for gold juniors looks the same. The gold juniors index, GDXJ, shows a similar pattern of disinterest in gold. Gold juniors remain in a downtrend, which tells you there isn’t much capital flowing into the sector right now.
In fact, the downtrend indicates a net extraction of capital from the sector. When gold is hot, you normally see money moving into the juniors first. This is clearly not happening.
My prediction then, is that gold stocks are going nowhere for the remainder of 2017. Unless the US economy weakens and the Fed takes rate hikes off the table, it’s likely that the downtrend will persist.
The hottest part of the market so far this year has been US tech stocks. It’s all about disruption, and the ability of these stocks to create new markets and grow earnings at a fast pace.
Investors have convinced themselves that tech stocks are the place to be. That’s especially the case when growth in a debt-soaked, low interest rate world appears hard to come by.
The hype over Amazon’s arrival in Australia is evidence of this. In the eyes of the market, everyone thinks Amazon’s business model is supreme and will take down the ‘old’ retailing sector.
That may or may not be true, but when everyone thinks something, you can be sure it’s all in the price.
So where to from here for tech stocks?
Let’s have a look at a chart of the Nasdaq composite index…
As you can see, it’s had a tremendous rally since the lows of 2016. The ascent has been very steep.
Given the combination of a sharp advance, stretched valuations and considerable hype around tech stocks in general, my prediction is that you’re going to see a sharp correction in tech stocks at some point in the second half of the year.
My guess is that the Nasdaq is in the process of topping out. That’s not to say that a big crash awaits us. But a decline of 15% or so wouldn’t surprise me.
Calling a top when the upward trend is so strong is a pretty dumb thing to do. Who knows how long the trend can persist? But as I said, the steepness of the trend, the high valuations and the considerable hype around tech stocks (who doesn’t own Apple?) all combine to give weight to the topping out view.
The process can take months to play out though. You’ve seen a really sharp advance during May and early June, followed by a one day panic sell-off in mid-June. Now, the index is trying to get back to its highs.
If I’m right, more selling will come at the highs as early investors take profits. This is called ‘distribution’. It’s when those who have been in the market for a while slowly get out of their positions in and around the top. They ‘distribute’ stock to those who have swallowed the hype and think now is a good time to get into tech stocks.
So expect to see increasing volatility in the Nasdaq over the coming months. If prices break down through the 6,000 level, I think you’ll see a hefty and fast correction after that. That’s because all those who bought thinking prices will keep heading higher will panic and sell.
But this is not the crash you’ve been waiting for. 10–15% corrections are the norm in stock markets. We just haven’t had one for a while. They are required from time to time. It’s the market’s way of restoring balance, of moving the emotion gauge from greed back to fear.
Fortunately, I think Australia’s market will be insulated from some of this. We’re not a tech stock heavy market. We haven’t had a strong run this year. Aussie stocks could even benefit from their ‘boring’ defensive characteristics.
Lastly, keep in mind this is just a prediction, as good or bad as all the thousands of others that are thrown into the financial ring on a daily basis. Whenever I make a prediction, I rest easy in the knowledge that I am probably wrong. You should think that too.