By Nigam Arora
U.S. stock market futures spiked as soon as the news hit that the U.S. and China would schedule high-level trade talks in October.
My opinion does not count, but the opinion of someone who is apparently connected to the Chinese government does. China’s Global Times editor tweeted: “There’s more possibility of a breakthrough between the two sides.” Let’s explore the issue with the help of a chart.
Please click here for an annotated chart of S&P 500 ETF /zigman2/quotes/209901640/composite SPY -0.20% , which tracks the benchmark S&P 500 Index /zigman2/quotes/210599714/realtime SPX -0.27% For the sake of transparency, this is the same chart that was previously published.
Note the following:
• The chart shows a “megaphone” top pattern.
• Bears have been making scary predictions, saying this is a bearish pattern and the stock market will fall to the lower trend line. This scenario would cause major losses for buy-and-hold investors who are fully invested.
• Bulls believe that not only there will be a breakthrough with China, but also that the Federal Reserve will be subservient to President Trump and aggressively cut interest rates.
• If bulls are right, the stock market will break above the rising trend line shown on the chart. This would be a new high for the stock market.
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What does it all mean?
I have previously written: “A megaphone top, when properly formed, can be useful in trading individual securities. However, the predictive power for a pattern that is not well-formed for the overall stock market is questionable.” I have also said that investors ought to be aware of the pattern, but there is no need for dread.
Start with Arora’s Second Law of Investing and Trading: “Nobody knows with certainty what is going to happen next in the markets.” Bulls believe that a trade deal will occur with China and the Fed will aggressively cut rates.
Prudent investors ought to consider an alternate scenario: If there is a trade deal with China, the Fed may not cut rates aggressively. If the economy picks up after a trade deal, the Fed may start raising rates again. Under such a scenario, gold ETF /zigman2/quotes/200593176/composite GLD +0.11% , silver ETF /zigman2/quotes/205744453/composite SLV -1.07% and precious-metals miner ETF /zigman2/quotes/206399889/composite GDX +1.86% would be crushed. Large-cap stocks such as Apple /zigman2/quotes/202934861/composite AAPL -0.68% , Facebook /zigman2/quotes/205064656/composite FB -0.32% , Google /zigman2/quotes/205453964/composite GOOG +0.27% /zigman2/quotes/202490156/composite GOOGL +0.18% and Amazon /zigman2/quotes/210331248/composite AMZN +1.46% will increase. Semiconductor stocks such as Intel /zigman2/quotes/203649727/composite INTC +1.59% , Micron Technology /zigman2/quotes/205710729/composite MU +2.27% , Nvidia /zigman2/quotes/200467500/composite NVDA -0.54% and AMD /zigman2/quotes/208144392/composite AMD +0.24% would be strong performers.
Keep in mind that bulls are not likely to have their cake and eat it too. This is the reason to follow a proven adaptive comprehensive model that has performed well in both bull and bear markets, such as the ZYX Asset Allocation Model.
Those heavily invested in bonds ought to be especially careful if interest rates rise. Bond holders can lose significant value in a very short time. Bond ETF /zigman2/quotes/206026314/composite TLT +1.05% would fall and inverse-bond ETF /zigman2/quotes/200202000/composite TBT -2.03% would gain. Of course, nobody is talking about rising rates at this time. The consensus is that rates will continue to fall. When there is such a high degree of consensus, it often pays to look at the other side.
Disclosure: Subscribers to The Arora Report may have positions in the securities mentioned in this article or may take positions at any time. <INTERNAL-PAGE URL="/author/nigam-arora">Nigam Arora</INTERNAL-PAGE> is an investor, engineer and nuclear physicist by background who has founded two Inc. 500 fastest-growing companies. He is the founder of The Arora Report, which publishes four newsletters. Nigam can be reached at Nigam@TheAroraReport.com.