November 17, 2016
Sir John Templeton wasn’t your typical Wall Street money manager.
His Templeton Growth Fund averaged a 14.5% return for 38 years, crushing the major indices. Every $10,000 invested in that fund in 1954 was worth well over $7 million by 2005.
What set him apart was the fact he never had a forecasting system, an ability to get out before a big market crash, or any other hard-to-replicate strategy.
None of that…
His secret was simple. He would buy at points of max pessimism and wait.
The best example was in 1939. Europe was just about decimated. So, Templeton bought every European stock trading below $1.00 a share and made a fortune.
And if he were alive today, I’m pretty sure he’d by a buyer of biotech names.
For example, just days ago, traders feared biotech and pharmaceutical stocks, greatly unaware that political risk had already been priced in. Instead, many ignored related trades, such as the iShares NASDAQ Biotech ETF (IBB), which turned out to be the wrong move.
Related stocks traded near historic low multiples creating potential buying opportunities. Amgen, Biogen, Celgene and Gilead traded at an average 12x earnings, as compared to the S&P 500’s 16.6x earnings multiple.
All were abysmally oversold.
Plus, you could see the fear, as thousands of traders followed one another right off the cliff, and sold at the wrong time.
But it’s that very fear -- that obscene point of max pessimism that you want to buy. Once the fear was removed, former bears piled back into biotech, as you can see in the chart below.
But how do we know when the fear has gotten way out of hand?
Is there a way to spot that technically? You bet.
Look closely at the chart. Look at three parts that highlight herd mentality and momentum, including Relative Strength (RSI), Money Flow (MFI) and Williams % Range (W%R).
Williams % Range (W%R)
When Williams moves to or above its -80, it’s an indication the asset is oversold. When it moves to or above the -20-line, it’s overbought. Look at how overbought the IBB was as the excessive pessimism punished it. That told us fear was getting way out of hand.
However, we never want to rely on a single indicator as a pivot signal, so we begin to confirm with RSI and Money Flow.
Relative Strength (RSI)
We can use RSI to confirm other indicators above. When RSI moves to or above the 80-line, we have an overbought condition. When RSI moves to or below the 20-line, we have an oversold condition. It confirmed what Williams was telling us.
Money Flow (MFI)
Money flow is another oscillator that uses price and volume to measure the strength of buying and selling pressure. We can also use MFI to confirm the other four momentum indicators above. When MFI moves to or above its 80-line, we have an overbought condition. When MFI moves to or below its 20-line, we have an oversold situation.
Each confirms the others perfectly and highlights how overbought or oversold a trade is becoming. When it comes to traders, too many of them trade on fear, which causes them to be irrational. When irrational fears (or greed) get out of hand, these three indicators above have a great track record of forewarning us.