Think out of box

The US market is extremely resilient and doesn’t want to give in to any selling pressure. All the three major indices have hit all time highs multiple times. It looks like Dow must have to go above 20000 before it will give up. But underneath the enormous bullishness, I’m still seeing technical warning signs. I stick to my earlier call that we are going to see some significant decline of the US stocks pretty soon. I of course don’t know when but I think it will be pretty soon most likely some time in January.

Fundamentally US stocks are very expensive as a whole and therefore contain substantial risks for buying them at this level. So where are cheap stocks that can be considered? Hold your chair before reading further as you may think I must have lost my mind to say that. I think it is a good time to think about Italian stocks!

Am I losing my mind? You see, Italy is currently the weakest link in the EU and its banking system is on the verge of collapse. They have just got the referendum done to vote down the current government and likely soon they will have an extreme conservative party leading the power that promotes to leave the EU. If that happens, EU will collapse and Euro will come to its end. So why I’m now talking about buying Italian stocks? Well the market must know something that we don’t know and it can often predict something months ahead. Clearly the market is telling me that Italian stocks are worth taking. Look at EWI, the ETF for the Italian stocks. After enormous turmoil in the past year, EWI simply refused to go down below $20. And then something amazing happened after the Dec referendum that was supposedly very negative for the country. EWI has mounted a forceful rally and jumped 25% within a month or so. Looking at its daily and weekly charts, technically EWI has a quite bullish momentum behind its recent rally. I think the market is clearly sending us a message that the most dangerous time for Italian stocks is probably over. I’m also puzzled about this but I think I at least partially know why. For one thing, the market has factored in all the major risks after it has come down so much in the past few years. Now the Italian stocks are probably one of the cheapest ones around the world. So fundamentally they are cheap enough with good valuation. The other reason is something I got from my son, who knows Europe very well, especially their political systems. He told me that even if the extreme conservative party gets the lead for the government, it is unlikely they would get the majority to have a single party government. Most likely they will have to find another one or more parties to form a coalition government. Because their policies and ideas are so extreme, they won’t easily find anyone that will simply join them without some major compromise, especially regarding the motion to leave the EU. So very likely, Italy will remain in the EU regardless of the election result. This indeed makes sense and I think the market is also thinking that way.

One caveat though. I don’t think EWI is a good buy immediately. After such a rally within such a short timeframe, it is a bit overbought. It is right at an important junction point around $25. This is a strong resistance it must overcome first. Either it decisively breaks out above 25 or it may more likely come down first to form a higher low. That will be an ideal entry point for me.