This 2022, inflation has made an appearance in style, both due to the conflict in Ukraine and due to the poor execution of monetary policies to heal the impact of the pandemic. According to prominent technical analyst Larry Williams, inflationary pressure is about to decline, which is why he has proposed a recovery scenario for stocks between now and the end of June.
What is Williams' argument? 邏
(If you don't have investment trainingsfinancial ion and you don't understand the data, don't worry, we have tried to make sure it is very well explained :D) To interpret Williams' chart-based analysis, it is helpful to understand two measures of inflation: 1. The consumer price index (CPI) flexible Tracks the cost of items that change prices rapidly: food, energy products, automobiles and hospitality. 2. The consumer's price index (CPI) base tracks the cost of items that change prices slowly: education and medical services, for example. Right now, the flexible CPI is high, in fact, higher than it has been at any of its peaks in the last 50 years.
Flexible CPI vs Base CPI of the last 50 years. Source: Bloomberg.
But if we remove food and energy, which are the most volatile items tracked in the flexible CPI, we can see a different view. Historically, this flexible CPI has been a reliable indicator of where the base CPI is headed next. And it looks like we have some good news, given that core measure exchange rates peaked last year, suggesting core inflation should start falling soon. In other words, we may have gotten over high inflation, it's just that investors haven't noticed it yet (and neither do our pockets...).
12-month flexible CPI vs. 3-month annualized. Source: CNBC.
What does this mean for stocks?
To answer this question, let's first look at another tool in Williams' analysis: The advance/decline line (in white), which tracks the number of stocks that are rising in value versus the number that are declining each day. It's a useful way to understand the strength or weakness in a stock market rally or decline, that is, whether a few top stocks are driving an entire index or whether most stocks are moving in the same direction. It's also helpful to try to predict where stocks will go next (in blue).
Advance and descent line with growth forecast. Source: CNBC.
That forecast suggests it's time for the advance/decline line to rise, which would mean a stock market rally that could last all summer. Of course, Williams' forecast also suggests that we will have a correction in August, followed by a rebound at the end of the summer. Of course, a drawback of Williams' methodology is that it does not tell us the size of a potential movement, so we do not know how high that rebound will go.
How can we take advantage of this opportunity?
If we are past peak inflation as Williams' analysis suggests, central banks may not end up raising interest rates as quickly as we all expected, which could be good for the market. Try combining the Williams scenario analysis and contrasting it with the technical analysis, which suggests that the stock should go up, and now could be a sweet time to buy the stock. There are two ways in which we can take advantage of this opportunity: (i) The first is by buying shares directly, through an ETF, to benefit from the possible rally. Given that the timing of our trading is often easier to determine than the timing of the market itself, it would be wiser to prepare for a volatile August, rather than trying to plan when to sell and when to buy back. He Vanguard Total World Stock ETF (VT) tracks actions around the world, so we could see how they are all developing globally.
Development of the Vanguard Total World Stock ETF over the last 3 years. Source: Morningstar.
(ii) The second is through the use of options: if we believe that the shares will rise and we want it to be more profitable, we can buy call options on stock market ETFs with a price above current levels (which gives us gives the right to buy at that higher price) even if prices rise further. Put options, which give us the right to sell shares at a certain price, could help protect us in the event of a sell-off in August. Combining call and put options with the same strike price is a strategy known as straddle- Allows us to benefit from stock market volatility in any direction. And of course, we can set up multiple straddles at different price levels and adjust them depending on how those potential rallies develop.
Explanation of the long Straddle strategy.
But we must be cautious, since while some people will argue that technical analysis provides valuable short-term trading signals, its critics will say that it is a fallacy. Thousands of studies have not convincingly moved the needle one way or the other. Still, whether we trust the signals or not, it's worth keeping an eye on them, because some investors will use them to make decisions. And when enough of them do, the forecasts of technical analysis can be fulfilled.