Fooled By Context, Or The Lack Thereof

August 23, 2021

Fooled By Context, Or The Lack Thereof

Are value and momentum investing two sides of the same coin?

News headlines often scream something along the lines of “XYZ hits a 8 month high” or “ABC falls to a 10 month low”, where 8 and 10 can be substituted for any number of your choosing. While good for grabbing people’s attention, such headlines tend to be more misleading than anything else, because just saying a data series is at an 8 or 10 month high or low doesn’t provide the key piece of information – relative to what trend?

Using EURUSD as an example, here’s a daily chart of the EUR’s huge rally in 2020.

EUR hit a 2 year high in Jan '21, but relative to what trend?

EURUSD hit a high of about 1.2350 in early January 2021, which naturally caught the media’s attention, and with good reason, since this was the highest the currency had traded since 2018! However, simply focusing on the fact that the Euro was at its strongest in slightly more than 2 years, and thinking that such bullishness could only mean that it would go even higher would have been a mistake. Why?

Because as a monthly chart of the currency pair (below) so clearly shows, EURUSD has been in a downtrend since 2008, with the ~1.2350 area actually where the previous big rally that started in 2017, topped out.

EURUSD has been in a downtrend for 13 years, which is the context all current moves in the currency pair

In other words, the Euro’s 2 year high in early 2021 was against the backdrop of a 13 year downtrend. With that context in mind, the 1.2350 level it reached was more likely to be a test of technical resistance (2018’s high) than a sign of unbridled bullishness.

Now that we’re past the middle of ‘21, it is clear that the Euro’s January high was indeed a test of resistance, since the currency has not managed to rally past it since then. Another attempt was made in the middle of the year, but EUR could only get into the 1.22 region. Of course the currency could still rally and break through resistance, since none of us really knows what will happen; but, given the long term context of the chart (13 year downtrend), this seems unlikely, at least in the near future.

This example illustrates quite clearly that what appears immediately impressive often turns out not to be from a longer term perspective. Consequently, what looks like a bull market could actually turn out to be a bear market rally, and if one doesn’t bother to zoom out the chart, it is all too easy to get fooled by a lack of context!