Will the market's breakout be successful?

In this post we'll take a look at what has been happening in the market since early June.

This information is taken from The Big Picture, to download a sample copy please just click here.

The good news is that the NASDAQ Composite has recently broken out of a bullish cup-with-handle base formation. But the big question is, will its breakout be successful?

Is the market’s current behaviour normal?

The way we use to check if the market is behaving as it should is to look at the trading action (price and volume activity) of institutional investors. Why do we do this? The stock market is about six month forward looking and its daily activity is the consensus conclusion whether institutional investors like or don’t like what they see happening down the road. By watching what the big players are doing (buying or selling) each and every day, it can provide essential clues to which way the market is likely to head.

It’s best to try to get ‘in sync’

Institutional investors control approximately 75% of the market’s future direction, which is why we aim to keep ‘in sync’ with them. If you don’t, it feels like trying to swim against a strong current. When you don’t get in sync, you often get hurt financially and that’s why we like to see if the 800-pound gorilla investors are buying, because when they do, it strengthens the market. However, if they are selling, it weakens it. The other thing we like to keep a close eye on is the behaviour of leading stocks.

If the market's best stocks are acting weaker than the general averages, it’s negative. However when leading stocks are outperforming the market, it’s positive. When leading equities are underperforming, the market is more likely to head lower, and if the market's premier stocks are outperforming, the market is likely to head higher.

Bull market? Bear market? Where are we?

Take a look at this 20-year chart of the NASDAQ Composite and you’ll see that the bull market that began in March 2009 (Point A) is just over five years old and for now remains intact.

Since the uptrend began, the NASDAQ Composite has made a very impressive 245.3% return. However, to make that gain it has had to experience three challenging corrections. The first (Point B) occurred from April to November 2010. The second (Point C) is a correction that started in May 2011 and ended in January 2012. The third (Point D), began in late March 2012 and finished March 2013. Right now the US technology index is trading very close to its highs (Point E).

Weekly chart of S&P 600 worthy of study

Small cap stocks often lead bull markets higher. But from time to time they need time to catch their breath before their next leg up. As you can see from this 5-year weekly chart of the S&P 600, the US small cap index formed a very strong uptrend from the summer of 2012 to December 2013 (Point F). This was when small caps were leading the general market higher.

Since the beginning of this year, the 600 has been moving sideways (Point G) and since March this year it’s been underperforming the general market. This underperformance can clearly be seen by looking at its declining relative strength line.

Our portfolio mirroring small cap index

Our investment account has been pretty much mirroring this index, also outperforming from summer 2012 to December 2013. Just like the 600, since the start of this year, our account has been resting and moving sideways. Our portfolio, just like the 600, also has been underperforming since March.

NASDAQ Composite breaks out of cup-with-handle

On the 18th June 2014, the NASDAQ Composite broke out of a 15-week cup-with-handle base formation (Point H). More recently it managed to get back above its old resistance area of 4371 (Point I). Its next job is to stay above this old resistance and ideally the 4371 price level will change from an area of resistance into an area of support. If it does this, it would help confirm that the general market is ready for its next leg higher.

A reliable indicator for predicting future market direction

The majority of the main US indexes are trading at or very close to their highs, which is normally seen as a positive. But we’ve always found that the best way to know if the general market is healthy (and likely to keep going higher) is to look how your portfolio is acting and whether or not the investments you own are surging forward.

Even though we always buy quality funds that own the market’s best stocks, our portfolio has definitely not been breaking any performance records lately and that tells us that something is either wrong with the market or that the rotation out of UK small and mid cap stocks continues. It also could be a combination of both. We have also noticed inflows into larger cap stocks. We are also surprised that our two new buys don’t seem to be making much headway but it is still very early days.

Recent behaviour confirms market back on track

On Thursday the 3rd of July, the market index action was positive. The NASDAQ Composite gained 0.63% (Point J) and volume for the day was way below average (Point K). When the market rises in tame trade it’s seen as a negative because it normally means institutional investors are reluctant to buy. However, volume was low because it was the day before the 4th of July, Independence Day, which meant that many institutional traders closed up shop early. This means the low trade can be excused.

From a price perspective, the US technology index made four days of gains in five outings (Point L). That’s what we call bullish technical behaviour. It’s also positive that the recent breakout attempt made 18th June (Point M), remains intact and the longer the NASDAQ can stay above the 4323 level (Point N), the price point where it broke out, the more likely it is to succeed.

This information is taken from The Big Picture, to download a sample copy please just click here.

As always, if you have any questions or thoughts on the points covered in this post, please leave a comment below or connect with us @ISACO_ on Twitter.

About ISACO

ISACO specialises in ISA and SIPP Investment and is the pioneer of ‘Shadow Investment’; an easy way to grow your ISA and SIPP at low cost. Together with our clients, we have an estimated £57 million actively invested in ISAs and pensions**. Clients like us because we have a great track record of ‘beating’ the FTSE 100***. Over the last 16 years, we’ve outperformed the Footsie by 60.2% and over the last 5 years, we’ve averaged 14.5% each year versus the FTSE 100’s 8.8%. You can find us at www.ISACO.co.uk.

What is Shadow Investment?

Picking the right fund for your ISA and SIPP is not exactly the easiest job in the world. And knowing 'when' to buy and 'when' to exit is even more difficult! Our ‘Shadow Investment’ Service is here to help. Our service allows you to look over our shoulder and buy the same funds that we are buying.

When we are thinking of buying a fund, we alert you so that you have the opportunity to buy it on the same day that we buy it. We also tell you about when we are planning to exit the fund. You control your investment account, not us. You can start small and invest as little or as much money as you like.

By knowing what we are buying, when we are buying and when we are exiting, throughout the year you can mirror our movements and in effect replicate our trades. This means you have the opportunity to benefit from exactly the same investment returns that we get. Our investment aims are 10–12% per year.

We are totally independent, fully transparent and FCA compliant. We’re warm, friendly and highly responsive and it’s a very personal service that gives you direct access to the Sutherland brothers; ISACO’s two founders.

Who are ISACO’s clients?

Clients who benefit most from our service have over £250,000 actively invested and the majority of them are wealthy retirees, business owners, self-employed professionals and corporate executives. We also have clients from the financial services sector, such as IFAs and wealth managers.

Do you have questions?

To have all your questions answered, call 0800 170 7750 or email us at: info@ISACO.co.uk.

* FT.com: www.ft.com/cms/s/2/836a4c76-d309-11df-9ae9-00144feabdc0.html#axzz2cUuPhGDH.
**November 15^th 2012: Internal estimation of total ISA and pension assets owned by ISACO Investment Team and ISACO premium clients.
***Long-term performance: December 31^st 1997 - December 31^st 2013 ISACO 91.3%, FTSE 100 31.1%. 5 year performance: December 31^st 2008 - December 31^st 2013. ISACO Investment performance verified by Independent Executives Ltd.