Mojena Market Timing

 Front Page      Timing Model      Reality Check      FAQ      Downloads      About      Mea culpa?

December 30, 2012

Timing Model at 63.7

Buy Signal on July 25, 2010*

Strategy

Current Position

2012 Returns

Cash

Money Market (T-Bills)

+0.1%

Buy and Hold

100% S&P 500

+15.9%

Standard Timing

100% S&P 500

+15.9%

Aggressive Timing

150% S&P 500

+20.2%

 

 

*The timing model issues buy and sell signals based on a mathematical/statistical score that ranges between 0 and 100:  Sell 43 or below; buy 78 or above. The standard and aggressive strategies determine the trades when timing signals are given.  Signal date is Sunday; trades based on next-day closing price. 

Market tumbles to 1402 on the “500” as we cling to the cliff; model tanks 20 points as technical indicators deteriorate.  Look for a good last trading day of the year if the pols reach some sort of agreement by Monday, however unambitious; another bad market day if not.  Still, the year’s returns look pretty good, for now.

Many happy returns in the upcoming year… and beyond.

 

January 1 update:  Market soars on last trading day as partial cliff deal is reached at the last moment.  Full year returns shown above.

December 23

Model: 83.5       Cash: 0.1%       Buy & Hold: 16.2%       Standard Timing: 16.2%       Aggressive Timing: 20.7%       S&P: 1430

It looked like an optimistic week out of Washington, with the stock market responding in kind, until the politicians smashed into the cliff wall by Friday, as did the resulting market selloff on that day.  Still, it could have been worse, and the overall gains for the week impressed, with the S&P settling at 1430.  With just five trading days left in the year, the year-to-date gains look pretty good.  But then those trading days left will not lack for drama as the political theatre continues to the “deadline.”  The model sits tight in comfort as the final act unfolds. 

Here’s wishing you a very Merry Christmas and Happy Holiday week.

December 16

Model: 80.3       Cash: 0.1%       Buy & Hold: 14.8%       Standard Timing: 14.8%       Aggressive Timing: 18.6%       S&P: 1414

Quiet week as market settles a bit below the flat line, 1414 on the “500.”  With just over two trading weeks left in the year and a looming negotiations deadline, expect less calm in the stock market.  Or we could end with a whimper if the negotiating parties agree to postpone this artificial deadline by leaving the status quo in place, until a more substantial deal than now expected is put together over the next several months.  Or maybe we have a temporary deal on tax rates with “promises” to seriously address tax and entitlement reforms in the coming year.  A headache for planning purposes and for the IT and budgeting folks, to be sure, but maybe best for the economy and markets. 

December 9

Model: 83.2       Cash: 0.1%       Buy & Hold: 15.1%       Standard Timing: 15.1%       Aggressive Timing: 19.1%       S&P: 1418

Market marks time as political negotiations continue and economic data on consumer sentiment and jobs, such as they are, ease concerns.  Some of you, I’m sure, questioned my SDS  trade last week, as inconsistent with the model’s buy signal.  True, from a longer-run (months to even years) perspective, the model’s perspective.  I also, however, do some short-term (days to weeks) trading to protect the stock portion of the portfolio with shorts when I see imminent events that might trigger a major slide (during a buy signal), as in the current fiscal cliff situation.  This is a tactical strategy that I use occasionally to minimize a possible maximum short-term drawdown within a retirement portfolio that I live off of.  The tactic is not a long-term trade based on the model.  These infrequent trading decisions are based on both judgment and the behavior of some short-term technical indicators that I pay attention to.  Note that the use of SDS allows me to protect all or a portion of the stock portfolio without selling stocks.  It’s standard temporary insurance by traders to be both long and short at the same time, during times of unusual uncertainty.  The trade is closed once the event shows more clarity and the indicators firm up.  Accordingly, I sold (covered) half the short position last week, with a whopping 0.2% gain.  Not all SDS, yet, as concerns still remain.  And note that the primary objective is not to make a profit, although that is certainly welcome, but to provide some degree of insurance… to temporarily insulate the portfolio from a possible shock.

Also note, as discussed in the third and fourth FAQs and elsewhere in these postings, that my portfolio is not entirely stocks; it carries some commodities (including gold), corporate bonds (including junk), and cash.  The stock portion is about 60% during a buy signal, give or take, a percentage I’m comfortable with during retirement and at my age.  In the 1990s I was 100% stocks during buy signals, a good thing given the magnificent returns during that decade.  And I strictly use ETFs over mutual funds.  When the model issues a sell signal I unload all stock and commodity positions, shift most proceeds to a money market, and the remainder (up to 10%) to SDS, in recognition of the aggressive timing strategy.

December 2

Model: 82.6       Cash: 0.1%       Buy & Hold: 14.9%       Standard Timing: 14.9%       Aggressive Timing: 18.9%       S&P: 1416

Market and model ease forward even as fiscal cliff negotiations apparently do not.  Let’s hope that what we read and hear are pre-deal public posturing and what we don’t see is private progress.  The market’s paranoid but somewhat positive tone suggests that a deal will be made before the end of the year, while fretting that we either get a “bad” deal or slip over the cliff.  This past week could be the last quiet week for the remainder of the year. 

Get ready for more taxation, and not just the “rich.”  Its many Federal incarnations (ignoring “fees”) include: income, payroll, dividends, capital gains, Medicare, Affordable Care Act (12 out of 21 new taxes that eventually impact the middle class).  Here are some quotes on taxation to think about:

Will Rogers (1879-1935)

There is some talk of lowering (the income tax), and they will have to. People are not making enough to pay it.

The crime of taxation is not in the taking it, it's in the way that it's spent.

The whole trouble with the Republicans is their fear of an increase in income tax, especially on higher incomes. They speak of it almost like a national calamity.

(The top Federal marginal rate went from 25% in 1931, when this was quoted, to 63% in 1932, as the depression worsened; it’s now 35% and likely rising.)

From a paper coauthored by Christina Romer, former Chair of President Obama’s Council of Economic Advisers

… tax increases are highly contractionary. The effects are strongly significant, highly robust, and much larger than those obtained using broader measures of tax changes. The large effect stems in considerable part from a powerful negative effect of tax increases on investment.

Our baseline specification suggests that an exogenous tax increase of one percent of GDP lowers real GDP by roughly three percent… and that [capital] investment falls sharply in response to exogenous tax increases.

(This National Bureau of Economic Research working paper from 2007 was subsequently published in the June, 2010 issue of the National Economic Review.  Shortly thereafter Romer resigned her position in the Obama Administration.)

From a Wall Street Journal editorial, November 30, 2012

It's the oldest lesson in tax policy: Tax something and you get less of it. In this era when envy trumps growth, the government is raising taxes on thrift, investment and risk-taking in the name of fairness and to finance more government spending. No one should be surprised when there are fewer dividends and capital gains to tax. 

(Note that these two taxes are investment taxes; see Romer quote.)

Capital Formation and the Fiscal Cliff, Thoughts from the Front Line, November 26, 2012, John Mauldin

…increasing taxes will drag down GDP growth in both the short and long term. The longer-term effect will be a decrease in available capital. That $50,000 that our millionaire does not have this year? Over ten years it becomes $500,000, and even more if the money is well-used. But if those funds cannot be invested in productivity-enhancing tools, services, and businesses, there will be fewer jobs and reduced consumption down the line. There are consequences. As a country, we must decide whether to pay that price. 

(Less private money means less capital investment, means less jobs; see Romer quote.)

For now, while this political football is unresolved, I’ve neutralized about 80% of my stock portfolio by buying SDS, the ETF that shorts the S&P 500 by twice (-2x).  In other words, I bought 40 cents of this trade per dollar invested in equities.  The bias still favors 20% of my stock ETFs, given the current buy signal, but with much less volatility.  I’ll sell this derivative when the fog clears over the next several weeks, assuming we remain on the buy signal.

November 25

Model: 80.3       Cash: 0.1%       Buy & Hold: 14.3%       Standard Timing: 14.3%       Aggressive Timing: 18.0%       S&P: 1409

Oversold holiday market on rising optimism and thin trading leaps 3.6% to 1409 for the “500;” model soars 49% to “safe” 80.  The market and model pull back from their own cliffs, rising to the middle of last week’s nearly 8% pullback from the September high.  Those of us who committed more funds to the market this past week should be happy, especially if this marks the end of the pullback and a confirmation of the primary uptrend that could take us to new bull-market highs.  By “safe” I mean to say that the model’s score is safely above an imminent sell signal and just outside its “sensitivity range” of 30 to 75, a range outside of which it’s less responsive to changes in its indicators.  Still, caution is warranted, as the market and model can respond dramatically to changing perceptions and events in Washington, Europe, and China… but especially Washington.  The remainder of the year is market-critical for such events.  For now, let’s celebrate good cheer, given the solid year-to-date returns.

Longer term is another story.  Government overreach is one of my main economic concerns.  The consequences are well stated by JP Morgan’s Kenneth Langdon, as quoted in the November 20 edition of Things That Make You Go Uhmmm… by Grant Williams. (It’s worth a read just for the Muhammad Ali quotes and analogy.)

The net result of this partnership between fiscal and monetary authorities is a continuous drain of productive capital from the private sector into the non-productive public sector. Little of that capital will be put to productive use once in the hands of government bureaucrats. As a result of this decimation of capital formation in the private sector, growth will be permanently lower, which in turn creates a negative feedback for the collection of taxes. Major economies are literally being bled to death by this drain of capital from productive uses. Voters are sanctioning this economic suicide.

November 18

Model: 53.7       Cash: 0.1%       Buy & Hold: 10.3%       Standard Timing: 10.3%       Aggressive Timing: 11.9%       S&P: 1360

Model stays on buy signal, although dropping 8 points as the “500” shaves 1.5% for the week to 1360.  The pullback now registers 8% from the 1466 peak two months ago, 5% just since the election.  Over this span the change in the model’s demeanor has been dramatic, a loss of 44 points.  As near I can tell, a drop in the S&P to around 1340 (another 1.5%) at the upcoming week’s close could result in a sell signal, a score 43 or below.  We are, however, entering a favorable seasonal period into the end of the year… so maybe we remain on this 2+ year buy signal, the market rises, and we have yet another pullback opportunity to commit more funds to stocks.  But then again… this is not your typical year.

Whether or not the model would have given a sell signal last week came down to last Friday’s market action.  The market calmed down and reversed its slide on that day, following the conciliatory tone expressed by both political sides post the President’s meeting with Congressional leaders.  Still, the model and market remain shaky.  The overriding concern right now is the fiscal cliff.  The market will rally should optimism grow that the issue will be resolved or at least postponed while negotiations continue into the new year.  Even so, the economy and market face serious headwinds over the coming year, so market action might remain choppy as it reacts in particular to Federal policies regarding expenditures and taxation, not to mention global concerns over Europe and China.  For now we remain on a week-to-week watch over the model’s judgment.

Let’s put aside our concerns and enjoy a Happy Thanksgiving.

November 11

Model: 62.2       Cash: 0.1%       Buy & Hold: 11.8%       Standard Timing: 11.8%       Aggressive Timing: 14.4%       S&P: 1380

Post-election market takes haircut with the S&P 500 selling off 3.4% to 1380 by week’s end; model responds more than in kind, collapsing 19 points or 23%.  The pullback now stands at 6% from the 1466 bull-market high in September.

The status-quo election results raise once more the specter of the fiscal cliff, first described in the August 12 posting: “The fiscal cliff refers to the looming tax increases (expiration of Bush, payroll, and other tax cuts and new taxes for dividends and the health care law) and legislated budget cuts (the debt ceiling deal) in January, 2013.” If a compromise between the President and Congressional Republicans is not reached before the end of the year, 2013 will surely include a recession, with obvious serious implications for the economy (read: jobs) and the stock market.  A comprehensive agreement regarding a tax policy overhaul (mostly the tax rate vs tax revenue/deductions debate) and deficit reductions (primarily entitlement and defense) is not at all likely in such a short period of time, but an agreement to delay the cliff into next year while a compromise is worked out is the more likely scenario.  Meanwhile, both sides will posture with their positions, the stock market will gyrate, and the media will have plenty of material to talk about.  Still, both sides should have ample motivation to make a deal, to overcome their paralysis, given the predicted dire economic outcome and the subsequent reelection consequences of not doing so.

The model, however, will not stand by idly.  The scope of its decline this week surprised me, primarily on greater than expected weakness in the market’s strength based on changes in trend and internals regarding up v down volumes, advances v declines, and new lows v new highs.  As best I can tell by running simulations (tricky because of so many assumptions), a decline this upcoming week similar to last week’s could trigger a sell signal.  This would mean a drop in the “500” into the 1350 neighborhood at the close on Friday, a distinct possibility if hope for a negotiated solution deteriorates based on what we see politically over the coming two weeks, especially following the meeting on Friday between the President and Congressional leaders.  Can Obama/Boehner pull off the beneficial compromises achieved by Reagan/O’Neill in the 1980s and Clinton/Gingrich in the 1990s?  Let’s hope so.  Or, given that we have the same players and issues now as before, with no mandate, does the next two-year election cycle begin now?  Let’s hope not.

November 4

Model: 80.9       Cash: 0.1%       Buy & Hold: 14.6%       Standard Timing: 14.6%       Aggressive Timing: 18.7%       S&P: 1414

Market and model flatline in Hurricane-Sandy-shortened week.  Now, we wait for next week’s election results.  From the posting on April 15:

Which party does the market favor?  While many believe that the business climate and economic progress are more favorable with Republicans in power, the historical record is confused at best, depending on many factors, including the political balance and dynamics within the three branches of government, ensuing legislation and rulings, the point in the business cycle, and worldwide macroeconomic and demographic conditions.  Just looking at the Presidential Cycle without the confounding elements mentioned, Fisher Investments determined the following:

* Third and fourth years of a presidential term are positive for the stock market, based on average returns.

* A switch in presidency from one party to the next is positive for the upcoming year, regardless of party.

* A re-elected Democrat is positive for the next year, whereas a re-elected Republican is negative, on average.

So, it looks just based on these stats that next year should be positive.

But then, these are averages with small data points.  My  judgment for this particular election, strictly based on economic and stock market considerations, is that a Romney/Ryan victory will be more positive for both the economy and market than an Obama/Biden re-election, over the next Presidential Cycle.  Fortunately, greater post-election clarity should be positive for either outcome.  And the fiscal cliff looms shortly, the European crisis subsequently, both game-changing outcomes.  Still, under current economic circumstances, it comes down to which policies will have a greater influence on positive economic growth regarding reductions in the national debt and deficits, tax reform, smart regulations, comprehensive energy, with an emphasis on domestic gas and oil and conservation, entitlement and market-based health care reform, and a leaner more efficient Federal government… policies that will encourage far more jobs than those of the past four (to twelve) years, especially in the small-business sector, the engine of job growth in this country.  Moreover, which candidate can better negotiate with the opposition party, a necessary talent for breaking the current gridlock?  Romney’s record as governor in Democrat-dominant Massachusetts speaks for itself.  My reading of the times, historical record and past research clearly favors the Romney/Ryan ticket. 

The April 15 posting continues:

Having said that, I listen to what the model tells me.  The model is apolitical, unemotional, neither politically correct nor politically incorrect, but… it’s not clueless regarding political events.  Its indicators do react indirectly to political policies that affect the economy and market.  For example, interest rates have become politicized to the extent that the Fed has become politicized: Not only do artificially low interest rates help the economy (in the short term, at the expense of fixed-income savers) but also lower the government’s debt service, as in paying off our mortgage with a low rate.  Several of the model’s monetary indicators monitor interest rates.  And its technical indicators that measure trends, volatility, and market internals such as volumes, advances and declines, and new lows and new highs themselves react to economic events that are affected by government policies.

An interesting, seminal time, to be sure, with potentially very long-term consequences.  To be continued…

October 28

Model: 81.4       Cash: 0.1%       Buy & Hold: 14.3%       Standard Timing: 14.3%       Aggressive Timing: 18.5%       S&P: 1412

Market resumes pullback on renewed concerns over the global economy in general and corporate earnings in particular.  The S&P 500 settles at 1412 for the week, up from the pullback low of 1409 last Wednesday, 4% below the September 1466 bull-market high.  It looks to me like companies might be hitting the wall to further cost reductions and productivity gains, thereby ending the current positive profit cycle, unless revenue rebounds sufficiently with a recovering economy.  With companies this lean, strong future top-line gains will turbocharge earnings and the next upleg of the bull market.  And it will be accompanied by more hiring and greater consumer confidence, important factors that promote revenue gains.  Meanwhile, more than the usual uncertainty will remain until there’s greater clarity regarding Europe’s proposed “solutions,” our fiscal cliff, and the election.  Which likely means that the market will remain choppy during this pullback and possible correction. 

The model retreated 12 points as some of its trend and technical internals weakened.  Still, while the model is on its buy signal, pullbacks in the 4 to 10% neighborhood more often than not present opportunities to beef up stock holdings, for those portfolios that remain underinvested. 

October 21

Model: 93.1       Cash: 0.1%       Buy & Hold: 16.0%       Standard Timing: 16.0%       Aggressive Timing: 21.2%       S&P: 1433

Last Friday marked the Black Monday stock-market crash on October 19, 1987.  In a single day the Dow plunged 23%, the S&P 500 20%, and the Nasdaq 11%.  A single day!  The worst single day ever, before and since.  Global markets also crashed and panic followed in the aftermath. Some headlines:

The Wall Street Journal

The Crash of '87: Stocks Plummet 508 Amid Panicky Selling

New York Times

STOCKS PLUNGE 508 POINTS, A DROP OF 22.6%; 604 MILLION VOLUME NEARLY DOUBLES RECORD

Bedlam on Wall St.

New York Post

CRASH: Wall Street's blackest day rocks nation

Los Angeles Times

Wall Street Panic

USA Today

MARKET ‘MELTDOWN’

Financial Times

Rout on Wall Street leads stocks to record falls

The selling far exceeded anything seen in the worst days of the 1920s and 1930s

I panicked along with most everyone.  The evaporation of retirement dreams, the loss of financial freedom? The 1980s up to then had been a very good decade for stocks; my portfolio was getting serious.  I sold half the portfolio’s stock portion on the 20th.  The aftermath?  A repeat of the 1930s?  The Dow bottomed that day, the “500” chopped its way to a low in December of that year, and the Nasdaq put in a bottom nine days later.  The indexes gasped to the finish line, slightly up for the year.  The decade returned an annualized 17% per year; the 1990s upped the ante to an annualized 18%.  Spectacular gains were realized over a twenty-year period, for those who stayed invested.  The best 20-year run ever!  Buy and hold was reborn.  Yet, a great number of investors were so frightened by the crash that they didn’t dip their feet in the market for years, some forever.  And then came the first decade of 2000.  A negative annualized return of 1% for that decade, punctuated by four bear markets with declines of 37%, 34%, 52%, and 28%.  That ten-year span trimmed a buy and hold portfolio based on the S&P 500 by 9%, including reinvested dividends; off 24% if not.  Ten years and we’re down 9 to 24%?  What a way to start the new millennium.  Devastation for many.  The lost decade. Cash was king. The buy and hold philosophy decimated, especially for those near retirement.  Once again, investors left the market in droves.  Were you in then?  Are you in now?

That crash in 1987, those days of terror, made for some soul searching.  My 1971 PhD was in quantitative analysis and finance.  The financial buzz since the 1950s included terms such as Modern Portfolio Theory (MPT), the efficient frontier, portfolio insurance, markets as random walks, the folly of timing the market.  “Folly” was a kind word.  It was more like “stupidity,” and worse.  Subsequently (in 1990) the Nobel Prize in Economics was awarded to three Americans for their pioneering work in the theory of financial economics, including Harry Markowitz for his development of MPT. 

Never mind.  Within a week of the crash I started thinking about and subsequently developing a model rooted in financial hypotheses and constructed with the building blocks of mathematical statistics and forecasting.  Invention is born out of necessity, alarm in this case.  After more trial and error than I would want to recount, or even remember, I had the first really good working model by mid-1989, with full-year implementation in 1990.  Each year since then the model has been tested, revised, and improved.  A new model each year. (All models gave sell signals one week before the ‘87 crash.) The current model is optimized (in theory) to max the value of the standard portfolio, based on historical data since 1970; the actual (live) performance of each model since 1990 (for its respective year) is seen in Reality Check.

I would not have retired in 2007 if not for the model’s guidance over nearly two decades.

By the way, the market last Friday celebrated the crash twenty-five years ago by selling off, a mere 1.5% to 2.2%, depending on the index.

October 14

Model: 92.6       Cash: 0.1%       Buy & Hold: 15.6%       Standard Timing: 15.6%       Aggressive Timing: 20.6%       S&P: 1429

No commentary… traveling.

Read travel blog.  (pdf file)

 

October 7

Model: 98.3       Cash: 0.1%       Buy & Hold: 18.1%       Standard Timing: 18.1%       Aggressive Timing: 24.7%       S&P: 1461

No commentary… traveling.

Read travel blog.  (pdf file)

 

September 30

Model: 97.5       Cash: 0.1%       Buy & Hold: 16.5%       Standard Timing: 16.5%       Aggressive Timing: 22.1%       S&P: 1441

Market marks two-week pullback, with the S&P settling at 1441, nearly 2% below the bull market high a couple of weeks ago.  A deeper decline could be in the works, offering once more a possible opportunity to beef up underinvested portfolios relative to risk, given that the model remains on its buy signal. 

As regular readers know, the benchmark index for the model and its performance is the S&P 500, the standard by which money managers and mutual funds are often evaluated.  During a buy signal my investments always include the ETF surrogate for this index, SPY.  As stated elsewhere in these postings, I also diversify by holding other ETFs that include stocks, bonds, and commodities.  In particular, I’ve focused on various technology investments, the clear strength of global and in particular American tech companies.  Keep in mind, however, that these investments are more volatile (have higher beta) than the “500.” Here are four tech categories that I either hold or consider during buy signals.

1. Digital content... This category is media in digital form such as digitized books, magazines, newspapers, music, video, animation, games, medical records, social media, you name it.  In short, anything that can be published, distributed, or used in digital form.   Creators and distributors provide the content and users fulfill the demand, especially with the increasing worldwide use of mobile devices such as smartphones and tablets.  Sales of these products and their apps are projected to continue their recent global surge.  Companies in this space are quite varied and include cable and satellite companies, content and device providers such as Amazon, Apple, and Google, entertainment companies such as Lions Gate, music companies such as Sony, news companies such as Gannett and News Corp, gaming companies such as Activision and n-Space, and on and on.  ETFs are tough to pinpoint here because the industry is so diversified.  See for example PBS.

2. Robotics... The field of automated machines is meant to replace humans in industrial, service, medical, military, exploration, and home settings, among many others.  iRobot (IRBT) is a leading company in this field.  Bloomberg lists over 100 automation/robotics companies.  This is another hard ETF to identify, as the space is very diversified.  See the technology equities category in the ETF Database.  See here for top ETFs that hold iRobot.

3. Additive manufacturing or 3D printing... This is a manufacturing process that "prints" three-dimensional objects using digital technologies.  This practice creates the object by successive layering of materials, unlike traditional manufacturing that decomposes materials by cutting, drilling, and shaving.  It's graduated from prototyping to full-scale, widely-varied and flexibly-produced products in diverse fields such as manufacturing, medicine, and archaeology.  And even includes smart phone apps!  A leading company in this field is 3D Systems (DDD).  Here are funds and ETFs that hold DDD.

4. Biotechnology... This category researches and applies living systems to make products in such diverse fields as medicine, pharmaceuticals, agriculture, energy, industrial processes, and marine biology.  Here's a list of the 100 top biotech companies and biotech ETFs.  I have invested in IBB and XBI since the buy signal in July, 2010.

I also always invest in QQQ during a buy signal, as a reasonable surrogate that crosses these four categories.  Moreover, the S&P 500 is about 20% tech.

For an excellent video on these topics see Alex Daley's presentation The Greatest Growth Sector in the World.  It’s long, but well worth it.  See also some of his other videos on the same page.

NOTE

I will be traveling abroad for a couple of weeks without my notebook computer, but should be updating the site using available wifi, my smartphone, and the Google cloud.  Postings will be barebones, no commentary, just stats.  Back stateside and regular postings on October 21.

September 23

Model: 97.7       Cash: 0.1%       Buy & Hold: 18.0%       Standard Timing: 18.0%       Aggressive Timing: 24.6%       S&P: 1460

Our benchmark index eases back to 1460 in quiet market week, despite demonstrations and attacks against US facilities in mostly Muslim lands.  The model remains copacetic and on its buy signal.  The market is somewhat overbought at this time, so a pullback would not be surprising.  As stated many times, very underinvested portfolios might use the frequent 3+% dips to add to stock holdings, while the model stays positive. 

Notable Quotes

Don't gamble; take all your savings and buy some good stock and hold it till it goes up, then sell it. If it don't go up, don't buy it.
Will Rogers


How did you go bankrupt?
Two ways. Gradually, then suddenly.

―E Ernest Hemingway, The Sun Also Rises

Perhaps more than anything else, failure to recognize the precariousness and fickleness of confidence – especially in cases in which large short-term debts need to be rolled over continuously – is the key factor that gives rise to the this-time-is-different syndrome. Highly indebted governments, banks, or corporations can seem to be merrily rolling along for an extended period, when – confidence collapses, lenders disappear, and a crisis hits.

Reinhart & Rogoff, This Time is Different: Eight Centuries of Financial Folly

 

…we risk passing an economic, fiscal and financial point of no return. The problems are close to being unmanageable now. If we stay on the current path, they will wind up being completely unmanageable, culminating in an unwelcome explosion and crisis.

The fixes are blindingly obvious. Economic theory, empirical studies and historical experience teach that the solutions are the lowest possible tax rates on the broadest base, sufficient to fund the necessary functions of government on balance over the business cycle; sound monetary policy; trade liberalization; spending control and entitlement reform; and regulatory, litigation and education reform. The need is clear. Why wait for disaster? The future is now.

Shultz, Boskin, Cogan, Meltzer, Taylor, The Magnitude of the Mess We’re In, The Wall Street Journal, September 16, 2012

 

September 16

Model: 97.5       Cash: 0.1%       Buy & Hold: 18.4%       Standard Timing: 18.4%       Aggressive Timing: 25.4%       S&P: 1466

Third round quantitative easing (QE3) is announced by the Fed and the market surges, the S&P 500 settling at 1466, a new high for the current cyclical bull market.  The long-term (secular) trend is likely to remain flat to slightly negative for several more years (it’s now 12 years) given the headwinds of the necessary and continuing unwinding of high debt by consumers (housing mostly) and governments (municipal, state, Federal and European).  Economic growth, main street and jobs in particular remain weak, and will continue to be so in the absence of effective, implementable (politically doable) fiscal policy regarding the budget, deficit, national debt, taxation, energy independence, and regulations. 

The Fed’s role in propping up the economy with easy money mostly had the effect of pumping up bank balance sheets and putting excess liquidity into assets such as stocks and commodities, as weak lending and demand and paltry bond returns discourage other forms of investment.  Hence the positive stock market responses to the three QEs.  But we don’t really know the extent of long-term consequences from an extremely skewed, unprecedented Fed balance sheet.  High inflation? Severely weak dollar? Declining U.S. sovereign debt ratings? Bond market crash?

As stated before, we don’t want to confuse a flat (or even down) secular stock market trend with its cyclical companion.  We are in a proven cyclical bull market that the model has jumped on for the ride.  Far too many investors have missed out on this three-plus-year bull, either based on advice regarding an unfriendly secular trend or paralyzed by excessive fear from the wicked roughly 50+% declines in the 2000-2002 twin bears and 2007-2008 bear.  I would have as well, if not for the confidence that the model provides.  World conditions and concern over a possible (however unlikely) black swan do make me more cautious than otherwise over a portfolio that fuels my retirement, but not so much so that I would ignore what the model is telling me. 

September 9

Model: 97.0       Cash: 0.1%       Buy & Hold: 16.1%       Standard Timing: 16.1%       Aggressive Timing: 21.8%       S&P: 1438

European bond purchase intentions and the possibility of additional easing by the Fed jump market to new cyclical high, as the S&P at 1438 reconfirms the bull market that began three and one-half years ago from the bear market low of 677.  This cyclical bull now shows an index gain of 112% over 42 months, putting it at about the median length and gain of bull markets dating back to 1932.  Accounting for dividends puts the increase at 127%.  Over this bull market run the model remained on a buy signal, except for the mistaken switchback (three-week) sell signal in July, 2010.  The model’s standard strategy gained 109%, the aggressive strategy 137%. 

The new high also justifies the model’s judgment that the 9.9% near-correction in June of this year was either (a) not a new primary downtrend that would lead to lower lows or (b) one that would be short-lived.  Since that time the “500” has gained over 12%. 

The flat to down secular (long-term) trend dating back to the all-time high double peaks (mid 1500s) in 2000 and 2007 remains in place… that is, until the S&P 500 comfortably exceeds these highs.  Our benchmark index now sits just 8% below the 1565 all-time high in October, 2007.  As stated elsewhere in these pages, a good timing model will show gains even when the market exhibits flat to negative secular trends, as it has over the past 12 years.  Most everyone makes money in a rising secular trend, but not so otherwise; it takes a good model and investment strategy to (mostly) ride the up market cycles and (mostly) avoid the down cycles that predictably fluctuate above and below secular trends. 

September 2

Model: 95.6       Cash: 0.1%       Buy & Hold: 13.5%       Standard Timing: 13.5%       Aggressive Timing: 17.9%       S&P: 1407

Market eases back second week straight, with the “500” settling at 1407.  The Republicans concluded their convention and the Democrats will have their say this coming week.  Then the campaign begins in earnest as the days to November 6 count down.  There will be more clarity on policy positions, especially as they affect the economy and stock markets. Traders and politicians are back from vacation.  World central banks look primed to stimulate, again.  Good for now, unintended negative consequences for later? Consumers, businesses, and economies remain uncertain.  October, the most volatile month of the year, is not far away.  And then there’s the election.  Buy the dips if very underinvested, as long as the model remains on its more than two-year buy signal, which shows gains of about 25% for the S&P and Dow and 34% for the Nasdaq, without reinvested dividends.  Add about another 5 percentage points to include dividends.  But let’s not get crazy, yet.

August 26

Model: 96.2       Cash: 0.1%       Buy & Hold: 13.8%       Standard Timing: 13.8%       Aggressive Timing: 18.4%       S&P: 1411

Ever so close.  Our benchmark index fails to technically confirm the cyclical bull whose start dates back to March, 2009, by not breaching the 1419 high that was scaled last April.  At 1411 the index is 109% above the 677 bear low in 2009 and 10% below the all-time 1565 high in 2007.  It remains just 8 points under the cyclical bull’s April high.  The market muddles within its recent trading range, although the model says the primary uptrend remains intact.  Recall that the model’s goal in life is to identify changes in the primary trend, an 8% or more reversal over at least eight weeks based on Friday closings.  As usual, the operating strategy for under-invested portfolios is to buy the frequent 3 to 7% pullbacks, at the expense of some additional volatility.  

August 19

Model: 96.6       Cash: 0.1%       Buy & Hold: 14.4%       Standard Timing: 14.4%       Aggressive Timing: 19.3%       S&P: 1418

At 1418 the S&P nudges up to within one point of the cyclical bull’s April high, as the rally marks six straight weeks of gains and extends its run to eleven weeks from the June nearly 10% pullback low.  The model barely moves, but remains on a high note, insisting that the primary uptrend remains in place.  The market continues its stealthy creep up as Americans and Europeans distract themselves over their August vacations. 

The S&P 500 VIX, a measure of expected volatility (risk or fear) used by the model, settled at a YTD weekly low, consistent with a quiet market and a positive for the model.  It will likely pick up over the coming months, as the market once again heats up, weakening the model by this measure.  Still, this is one indicator out of 15 and one data point out of 20 currently used by the model.  The model is more complex than one data point or indicator; market reality far more so.  No complaints here…it’s a very good year for the market and the model’s strategies, so far.

August 12

Model: 96.4       Cash: 0.0%       Buy & Hold: 13.3%       Standard Timing: 13.3%       Aggressive Timing: 17.8%       S&P: 1406

Market adds gains in calm week as YTD returns settle at new high for the year.  At 1406 the “500” is 1% below its April cyclical high and just 10% below its all-time high in 2007, five “long” years ago.  Do we break out above the 1419 April ceiling or do we head toward the lower half (below 1348) of the recent trading range, a 4% or more dip from here?  The model and its technicals favor an upside breakout.  High negative sentiment also favor a continuation of the uptrend.  Far too many investors have missed out on this bull run.  Europe and the fiscal cliff remain serious concerns, for sure, although the former’s “can” keeps getting kicked down the road.  More reckoning is sure to come over the next year or two.

The fiscal cliff refers to the looming tax increases (expiration of Bush, payroll, and other tax cuts and new taxes for dividends and the health care law) and legislated budget cuts (the debt ceiling deal) in January, 2013, with likely very negative consequences for a US economy that’s at or near another recession.  For more details see What is the Fiscal Cliff?  Grant Williams states it this way in his July 22 newsletter:

In the run-up to December 31, you can guarantee that the issue of the US Fiscal Cliff will replace Europe as the major con­cern facing the world in general and the US in particular and, if things continue to deteriorate at their current pace, any­thing that will lead to even a 0.5% cut in GDP will be seen as a disaster.  Morgan Stanley said this week that concerns about the fiscal cliff are reaching new heights across a wide range of industries. It is already seeing reductions in business orders and hir­ing, among other areas. ...a stop-gap measure will be found to enable the can to be kicked once more down the road...‘The Fiscal Cliff’. Familiarize yourselves with it, folks. You’re going to be hearing a lot more about it from here on in, I promise you.

Consequences could be dire, with political fallouts for both parties, so most likely there will be a compromise “solution,” probably after the election.  Another can?

August 5

Model: 95.3       Cash: 0.0%       Buy & Hold: 12.1%       Standard Timing: 12.1%       Aggressive Timing: 15.9%       S&P: 1391

Market swoons as Draghi/ECB and Fed disappoint (see last week's post); market recovers (overreacts?) on decent jobs report and “hope and change” from Europe; model yawns.  The “500” at 1391 is in the upper part of its recent trading range, just 2% below the current cyclical bull’s 1419 high.  We remain hostage to the European drama: its economy and globally interconnected banks impact our own economy and markets.  No short-term solutions here.  The buy-signal strategy remains operational: dips are opportunities to buy for underinvested portfolios that are willing to take on more risk.

July 29

Model: 95.0       Cash: 0.0%       Buy & Hold: 11.6%       Standard Timing: 11.6%       Aggressive Timing: 15.3%       S&P: 1386

Thank you Mr. Draghi, Super Mario!  The European Central Bank president’s “whatever it takes” remark to save the euro also saved this week’s market.  Over the first three days of last week, the “500” took an additional 2% haircut, bringing its dip to 7% below the 1419 cyclical bull high-water mark, providing another good opportunity to “buy the dip.”  Then the remark… and the market got giddy, gaining nearly 4% in two days to close up for the week at 1386.  No protest from the model as it popped nearly 5 points to a very comfortable 95, propelled by firmed-up technicals.  And no matter that Gross Domestic Product in the second quarter came in at an anemic 1.5%, all the more reason to anticipate further Fed action that stimulates the economy in principle, but the market in reality (see last week’s comment).

Regarding the GDP number, here’s what the Wall Street Journal had to say:

“The most recent comparable recession occurred in 1981-1982 [deeper than the recent December 2007 to June 2009 recession]. Yet as the nearby chart shows, the Reagan expansion exploded with a 9.3% quarter and kept up a robust pace for years. By the 12th quarter of expansion, growth popped up to 6.4.%. At this stage of the Reagan expansion, overall GDP was 18.5% higher versus 6.7% for the Obama recovery, according to Congress's Joint Economic Committee… This may sound like an abstraction, but it is the difference between a robust job market and lost opportunity for millions of Americans. It is the difference between a small federal budget deficit and more than $1 trillion for four straight years. It is the difference between a rising or falling poverty rate.”

It’s tricky and maybe unfair to compare two recessions, as their causes differ and the usual assumption “all other things equal” in economic models never reflects reality.  Still, stats are stats and consequences are consequences. 

Following the GDP report the New York Times comments:

“The mired recovery makes the United States more vulnerable to trouble in Europe and, at home, the potential expiration of several tax breaks and other buoyant measures at the end of the year, known as the fiscal cliff.”

Still, no complaints here regarding the market.  Just look at the YTD figures above.  Do we work our way higher? The model just says last week’s close is consistent with a primary uptrend.  Expect continued volatility as Europe deals with its crisis and we deal with a looming “fiscal cliff.”  The market could take a hit this week if the ECB and political leaders don’t follow up on Draghi’s promise.  More on these topics in future posts.

July 22

Model: 90.3       Cash: 0.0%       Buy & Hold: 9.7%       Standard Timing: 9.7%       Aggressive Timing: 12.4%       S&P: 1363

The week was looking good as fine earnings and the prospect of more quantitative easing (QE) from the Fed sparked mini-rallies, and then...  Europe wobbled on Friday as Spain got grimmer.  Still, the major indexes managed gains for the week, with the S&P stabilizing at 1363.  There’s little evidence that QE1 and QE2 helped the “real” economy (things like jobs and income), but there’s good evidence it propelled stocks and eased the government’s debt service (lower interest payments through lowered rates).  It will likely be more of the same with a QE3, although probably less intense as the Fed’s bullets get spent.  So, bad economic news begets thoughts of more QE, good news for the market as the thinking goes.  And when it doesn’t?  Probably the beginning of another cyclical bear, unless government policies that encourage real economic growth are put in place: Such as targeted infrastructure spending by government, policies that promote capital investment and innovation in the private sector, a market-oriented energy program, and simplified regulations, health care, and tax codes that help small businesses in particular.  Too complicated for sure.  I’ll let the model sort it all out as we move along.

The operating strategy during a buy signal continues: buy the frequent 5 to 10% dips if underinvested.  From May into June the “500” spent about six weeks in this “buy the dips” range; it’s currently 4% under the April 1419 high.  Looking for less volatility in your investments?  See these ETFs.

July 15

Model: 90.1       Cash: 0.0%       Buy & Hold: 9.2%       Standard Timing: 9.2%       Aggressive Timing: 11.7%       S&P: 1357

The “500” breaks a six-day losing streak with a Friday rally that saves the week, barely, at 1357.  The index now stands 4% below the April cyclical high and 6% above the pullback low on the first day of June, somewhat above the middle of its recent 1278-1419 trading range.  The operating strategy during a buy signal is to buy the dips, for underinvested portfolios that are willing to take on more risk. 

Remember that the model’s portfolios are either in or out of stocks completely, to properly compare their performances to buying and holding the S&P 500, the most common benchmark index against which returns are measured.   As cited often on these pages, portfolio investments should be diversified not only across stock classes but also across other assets such as bonds, commodities, real estate, and money markets.  The percentages in each class are typically a function of expectations and risk profile, the latter determined by an investor’s propensity for risk, age, and other circumstances.  A simple and generalized often-cited allocation for a mid-life investor is 60% stocks and 40% bonds.  Younger investors might allocate more to stocks and older investors near or in retirement might allocate less.  In my case, at 70 and living off my portfolio in retirement, during a buy signal (about 70% of the time) I invest up to 55% in equity ETFs (SPY, QQQ, and others such as IBB, IWM, VWO, SCZ, VIG, GRID, and XLU); no more than 15% in commodity ETFs, such as energy equipment and services (VDE or XLE), water (PHO), or a commodity index (DBC); 5% in gold (GLD); the remaining 25% or more in bonds (TLT, LQD, JNK) and a money market.  During a sell signal I dump all stocks and commodities and allocate the proceeds to a money market account and up to 20% short positions such as SDS and EPV and maybe TBT in place of TLT. 

Note the following:

·         The model’s predictive focus is the S&P 500, which reflects about 75% of total stock market valuation.  Many other stock index and ETF alternatives are highly correlated to the “500.”  This means they tend to move in the same direction, but not the same magnitudes or rates.  This implies that a buy signal based on the S&P 500 is also relevant for many other equity investments.

·         My max target percentages are riskier than normal for my circumstances, a stance I’m willing to take because of confidence in the model. 

·         But… I’m currently below my target maxima, and more cautious than usual, as stated in recent posts, with about 50% committed to stocks and commodities, rather than my normal 70%.  If the S&P were to drop near the lower end of its trading range, I would allocate more to the market, as long as the model stays on its buy signal and is at or above the middle of its 43 to 78 sell-buy range (about 60).  See, for example, June 3 as a good buying opportunity.  

July 8

Model: 89.4       Cash: 0.0%       Buy & Hold: 9.0%       Standard Timing: 9.0%       Aggressive Timing: 11.4%       S&P: 1355

Friday’s weak jobs report and renewed concerns over Spain unsettled markets, leading to a global selloff.  The S&P and Dow trimmed just one percent for the week, while the Nasdaq barely kept its head above water.  Déjà vu all over again?  Expect more of the same up/down weekly action as we likely work our way from the current S&P 1355 to the high end of the three-month 1278 to 1419 trading range.  A breakout to the upside will probably require greater certainty that acceptable resolutions are underway for the known negatives.

Why does the model remain bullish with all of the bad news that’s out there?  Its  technical indicators are positive, as are its monetary and fundamental indicators. Moreover, the widespread negativity is very positive for the model’s contrarian indicators: investor pessimism is high, as in the weekly bull/bear stats put out by the American Association of Individual Investors; mutual fund managers and individual investors are hoarding cash.  In other words, too many market participants are already out of stocks and will use their cash piles sometime in the future to reenter the market, rather than letting these funds languish forever under the “electronic” mattress.  Greater certainty and confidence will set this pattern in motion.  Most of the tentative investors already have been shaken out of the market, judging by the huge cash outflows from stock funds over the past three years (during a bull-market run!).  There are less investors left that are likely to sell.  Out of fear precipitated by the savage 52% 2007-2008 bear market and the follow-up 28% flash bear in early 2009, far too many investors have missed all or a major portion of the current 113% gain (with reinvested dividends) from the March, 2009 low that started the current cyclical bull. (The model scored a 96% gain.)  By the way, the S&P marked a 55% net loss over the span of the two recent bears (October 2007 to March 2009), even accounting for the intervening 24% flash bull; the live model lost 38% over this 17 month time frame.  Combining the losses and gains from the October 2007 all-time high (and the start of that bear market) to now shows the following: the “500” lost 4% over the last 57 months (over nearly five years and accounting for dividends!) while the live (in actual use) model gained 22%, a 27% advantage for the model.

What catalyst might increase confidence and bring these late investors back into the market, fueling the next leg of the current run?  Maybe the November election and political (bipartisan) agreements that yank us back from the “fiscal cliff” before the end of the year?   Yet, it could get much worse as well, before it gets better, as in a eurozone meltdown.  The model watches and processes, rendering its judgment at the end of each week.  It’s the model’s buy signals that give me the confidence to stay in the market during trying times.

July 1

Model: 94.1       Cash: 0.0%       Buy & Hold: 9.5%       Standard Timing: 9.5%       Aggressive Timing: 12.4%       S&P: 1362

The market liked Friday’s European summit news, the “500” popping 2.5% on that day, reversing a weekly loss up to that point and ending at 1362.  The model approved of the technical action, jumping 19 points to a very solid mid-90s.  Why the good news?  The eurozone agreed, with Germany’s apparent blessing, to directly cash transfuse bailout funds to ailing banks, bypassing governments and thereby avoiding greater sovereign (governmental) deb.  Band-Aids.  Libertarian economist Doug Casey amusingly puts it like this:  So you've got two sets of bankrupt institutions [banks and governments] trading debt back and forth between themselves.  No agreement to buy up troubled bonds, nor details on increased fiscal controls.  The devil will be in the details.  Expect continued euphoric and despairing reactions to come, depending on announcements and financial realities.  We’re going to live with this for some time.

The Supreme Court essentially upheld the health bill; the market reacted little, except for the principal health care players: hospitals rose smartly, expecting more paying patients and greater efficiencies, although what states will do with the Medicaid expansion component is uncertain; health insurers declined, on the basis of cost squeeze requirements and uncertainties on just how many individuals and businesses might opt out of premiums and into penalties, oops, “taxes;” medical device makers also declined, expecting additional taxes; pharmaceuticals were flat, protected by agreements and by expectations that volume increases will be negated by additional fees and generics.  And it’s going to cost you more to go to a tanning salon!  Look for lobbying by hospitals, drug companies, insurers, device makers, businesses, labor unions, state governments, and other participants affected by the law to change specifics and implementations to their benefit.  Moreover, in no small way, the fate of health care and its mid- to long-term economic consequences will be left up to the electorate in November… and to our politicians and technocrats now and in subsequent years. 

June 24

Model: 74.8       Cash: 0.0%       Buy & Hold: 7.3%       Standard Timing: 7.3%       Aggressive Timing: 9.0%       S&P: 1335

Two-hundred-fifty point Dow swoon on Thursday puts the kibosh on the market for the week, with the Dow and S&P backtracking 1%; the Nasdaq bucks the trend, advancing about half a percent.  The model eases back as well, shedding 8 points.  Volatility continues, with Thursday’s selloff a response to renewed concerns over the global economy.  The gush of bearish global data was followed after the close by a Moody's downgrade of 15 global banks, including the 5 largest US lenders, citing significant exposure to volatility and the risk of large losses from capital markets activities.  Yet, the market rallied on Friday, most likely a response to buying the dip from the previous day and relief that the downgrades were not as bad as the worst-case-imagined scenario.  So, we sell off on downbeat news; we rally on positive, hopeful, or "it's not as bad as we thought" news.  The beat goes on…

This week the Supreme Court will announce its ruling on the health care law.  Regardless of the decision, it will have profound effects over the long run, both socially and economically.  It should have an immediate effect on the stocks of healthcare providers… hospitals, pharmaceuticals, insurers, managed care companies… each reacting differently depending on the outcome… but the decision will not likely affect the overall stock market for long, if at all.  Looking out over decades, however, the quality and availability of health care for our citizens are surely serious concerns.  And the impact on medical costs for consumers, companies, Medicare, and Medicaid will certainly affect the market’s secular trend, either positively or negatively, depending on what we end up with.  If the law stands, it will have to be revised to overcome the currently projected negative cost impact on the economy; if struck down in whole or in part, it would be back to the drawing board, adding to uncertainty.  And hopefully next time it will better address the shortcomings of both the current law and the current state of healthcare.  For example, the law has the noble and morally desirable, even imperative, goal of expanding health care coverage for all; yet it falls far short of means by which to reduce and even moderate the economic impact of health care.  (Read David Walker interview.)  Moreover, many critics argue that the quality of health care will suffer as well under the law, assuming a scenario of more patients and less providers (driven out by costs and regulations).  Woody Brock’s seminal book American Gridlock: Why the Right and Left Are Both Wrong - Commonsense 101 Solutions to the Economic Crises shows through rigorous deductive logic how increasing the nature and quantity (supply) of health care would not only increase coverage but also both improve quality and reduce cost.  Easier deduced than done… all too often politics on both sides get in the way.  Let’s hope we eventually get it right.

June 17

Model: 82.7       Cash: 0.0%       Buy & Hold: 7.9%       Standard Timing: 7.9%       Aggressive Timing: 10.0%       S&P: 1343

Rally continues in volatile week; model firms up as it settles within its “comfort” zone (above its buy trigger of 78).  At 1343 the “500” sits in the center of its 9.9% “baby” correction from high to low: 5% above the 1278 low on June 1 and 5% under the 1419 April 2 cyclical bull high.  So far, the correction has offered a buying opportunity for underinvested portfolios relative to risk, the operating strategy while the model remains on its buy signal.  And the buying opportunity remains, although the expected continued volatility is not for the faint of heart.

The perverse rally this past week perplexed many market observers, given the usual negative news regarding continued Greek, Spanish, and Italian woes.  Jobless claims, retail sales, and industrial output were all shaky, further adding to concerns.  So what gives?  The market is a forward-looking mechanism… and the forward look right now is that global central banks will coordinate additional easy-money policies, economic “firewalls,”  through sovereign bond market manipulations, lowered interest rates (a third Quantitative Easing or QE3 in the US?), and a relaxation of global banking rules known as the Basel accords.  We will see how long these measures might be effective.

Right now all eyes are on the Greek election today, which could signal a monumental shift in the cohesiveness of the European Union, Europe’s “Lehman moment,” should Greece lurch to the left and signal it will not honor its austerity commitments, with a possible eventual exit from the eurozone.  If this were the case, I would expect the market to first react negatively, then follow with another rally as concerns are soothed by positive offset policy pronouncements, starting this week with the G-20 powwow in Mexico and the Federal Reserve meeting, and followed by the EU summit later this month.  Still, volatility will continue, as the sobering realities are re-examined and solutions are questioned, again, and again, and again… until more clarity is established as the global economic system rights itself.

John Mauldin’s recent post The Bang! Moment is Here is a worthwhile read regarding the European crisis, including quotes from This Time is Different.  He ends it with this comment:

But change is coming to Europe. One way or another, a new order and a new balance will be forced upon them. Either a fiscal union or break-up. They have kicked the proverbial can down the road until it will roll no more. You can feel the Bang! moment arriving. This is the Endgame.

What to do should the market turn south in the near future?  One offsetting investment is EPV, a twice short (-2x) on a European stock index.  This is a volatile short-term investment that will move opposite to a US stock portfolio, given that US and European stocks are highly correlated.  I have a small position in this ETF from time to time, depending on short-term market moves and moods, as a partial offset to declines in my portfolio based on negative reactions to European events.  US long treasuries using TLT is another risk-off small position that I’ve taken, to further insulate my portfolio from declines.  Overall, my portfolio remains on a cautious buy, explained in previous posts, while I let the model guide me as it monitors market reactions and makes its judgments. 

June 10

Model: 72.9       Cash: 0.0%       Buy & Hold: 6.4%       Standard Timing: 6.4%       Aggressive Timing: 7.9%       S&P: 1326

What a difference a week makes.  S&P pops 3.7% to 1326, while the model firms up 13 points.  Still, the model is inside its sensitivity range 30 to 75, within which it can change very rapidly.  For now, though, it’s looking like the near-correction might be over, with the market and model suggesting a primary uptrend remains in place.  Yet, problems are far from solved, either just words and intent or minimalist solutions for now from the power elite, so volatility is likely to continue until comprehensive  policies are put in place that engender certainty and confidence, in the US,  Europe, and China.  The next few weeks could tell some stories, as Greece holds new elections June 17 (A further turn to the left and a more likely eurozone exit?); the Federal Reserve's rate-setting committee meets June 19 and 20 (More stimulus?); and European Union leaders convene yet another summit on June 28 and 29 (Will they rescue Spanish banks?  Will Germany agree to the issuance of eurobonds in return for greater centralized fiscal controls?).  Well, maybe Greece doesn’t step up to the plate, for now.  As of this writing, the union employees who work the Greek election are threatening a strike unless they get more pay.  Is there hope for Greece?  Take a look at this video.

Here’s my take, my crystal ball… If proposed solutions are unconvincing and the market reacts to the downside, the model might issue a sell signal sometime this summer, probably sooner rather than later.  More likely, hope springs eternal and we muddle along with a buy signal.  We will get a sell signal at some point as the primary trend changes to negative and we likely enter a cyclical bear market, say, within the next year.  And then, when the dust clears, we’re in for a long, sustained, and significant secular bull market, two, three, or four years from now.  Meanwhile, my portfolio remains on a cautious buy signal, as explained in earlier posts… and the model keeps its ear to the ground as it relays the rumblings it hears.

June 3

Model: 60.1       Cash: 0.0%       Buy & Hold: 2.6%       Standard Timing: 2.6%       Aggressive Timing: 2.2%       S&P: 1278

Market renews slide, the S&P tanking 3% for the week to 1278, not liking the recent news from Europe, China, emerging markets, and US jobs; the model responds in kind, sinking 17 points, yet retaining its two-year-old buy signal.  The pullback now stands at the door of an “official” correction, 9.9% from the cyclical bull market high of 1419 last April and 18% below the all-time 1565 peak in October, 2007.  And the model’s definition of a primary downtrend (8% decline over at least eight weeks) is nearly confirmed.   As posted on May 20:  “Corrections in this neighborhood are in the vicinity of the model’s design boundary, meaning it can give the model fits if we just have a sharp, short correction within a bull market, which is what happened in 2010.  Or, we might be on the verge of a sell signal in a new bear market, as in June, 2008.”  My sense is that we likely remain in the flat to down secular  trend from 2000 that will continue for maybe several more years, until the unwinding of the public and private debt supercycle plays out.  This unwinding also includes an eventual fix to the eurozone crisis, which could include the departure of one or more countries and possibly the ultimate federalization of Europe, a union of countries with a monetary and fiscal central authority, as in the US. 

Now, we do have cyclical bull markets within secular trends.  The current example would be the 110% cyclical bull that began in March, 2009, should the April top define the beginning of a new cyclical bear.  Still, cyclical bears are more likely to occur and with greater intensity during secular downtrends, than not.  So, it would not be surprising that we’re now in a cyclical bear.  Yet, the model does not directly deal with bear markets; rather it attempts to define whether or not the past week is consistent with a primary down or up trend.  And, as would be expected, primary uptrends are more frequent during bull markets, as primary downtrends are during bear markets.  For now, the model judges that we remain in a primary uptrend, although the strength of that judgment has weakened considerably (its probability is down to about 60%).  As best I can tell, a decline to the neighborhood of 1235 (about 3.4% from here) at the Friday close could trigger a sell signal.  The present near-correction could also be an opportunity to increase equity holdings, for underinvested portfolios relative to risk, should the currently oversold market reconfirm the primary uptrend and buy signal with a rally over the coming weeks. 

May 27

Model: 77.5       Cash: 0.0%       Buy & Hold: 5.7%       Standard Timing: 5.7%       Aggressive Timing: 7.0%       S&P: 1318

Market rallies on Monday and then flatlines the rest of the week, as the S&P 500 goes to bed at 1318; model jumps 10 points while its technical indicators settle down.  The S&P 500 now stands nearly 2% above its pullback closing low on May 18 and 7% below the bull market closing high on April 2.  Is the 9% pullback over or is this a pause on the way to a new primary downtrend and possibly the confirmation of a cyclical bear market?  Answers might be just weeks away. 

Last week’s meeting of the European Council in Brussels was inconclusive and the new Greek election on June 17 could be a game changer masquerading as a referendum on leaving the eurozone.  Europe looks like it has slid into recession and China continues its slowdown, suggesting negative future implications for world economies. Moreover,  the Economic Cycle Research Institute is forecasting a contraction this year for the US.  The eurozone crisis is so dicey and the economic outlook so pessimistic that I’ve cushioned my portfolio for some weeks now with ETF positions that are negatively correlated with my ETF stock positions: long-term Treasury bonds using TLT and European stock shorts using EPV.  Still, my net stock position remains long, while the model stays on its buy signal.  For now, the model appears to believe we will muddle on.  Stay tuned.

May 20

Model: 67.9       Cash: 0.0%       Buy & Hold: 3.8%       Standard Timing: 3.8%       Aggressive Timing: 4.3%       S&P: 1295

Eurozone realities smacked the market hard last week, pummeling the S&P 500 4% to 1295.  Our benchmark index is now about 9% below the 1419 bull-market high just under seven weeks ago.  The model reacts in kind, sinking 16 points, primarily based on deteriorating technical indicators that reflect trends, momentum, strength, and relationships among volumes, highs v lows, and declines v advances.  Its current score of about 68 puts it within its sensitivity range of roughly 30 to 75, meaning that it can change dramatically in either direction within this range.  Poor market performance this coming week could ratchet the score below its 43 sell point, thereby issuing its first sell signal since July, 2010.  That signal was a three-week switchback based on a short, sharp correction within an ongoing bull market.  (See Reality Check.) The current buy signal is now two months short of two years and shows a gain of 16% based on the S&P (plus dividends of about 5%).  The still intact (until proven otherwise) cyclical bull market dates back to March, 2009 with an index gain of 92% (plus 8% dividends).  Compared to averages, the current bull is somewhat shy in length and return. 

So, what now?  The ongoing pullback is just short of the 10% correction standard and well under the 20% bear market definition.  The model is theoretically tuned to detect a primary downtrend as an 8% or more decline over at least 8 weeks.  We now stand at 9% over 7 weeks.  Corrections in this neighborhood are in the vicinity of the model’s design boundary, meaning it can give the model fits if we just have a sharp, short correction within a bull market, which is what happened in 2010.  Or, we might be on the verge of a sell signal in a new bear market, as in June, 2008.  We’re now in a critical week regarding the model’s behavior.  As best I can tell, an S&P drop to as little as 1265 (a 2.3% decline this week) or as much as 1210 (6.6%) might trigger a sell signal, based on scenario simulations for the coming week.  I say “might” because the model’s complexity includes data for indicators that are impossible to accurately predict from one week to the next, not to mention counterbalancing reactions among the indicators.  The sell trigger could be somewhat below 1210 or above 1265.  Remember that these index numbers are based on the week’s close, usually Friday.  A market bounce this coming week would preserve the current buy signal.  The market and model now bear our undivided attention.

May 13

Model: 83.9       Cash: 0.0%       Buy & Hold: 8.5%       Standard Timing: 8.5%       Aggressive Timing: 11.5%       S&P: 1353

Market eases back to 1353 as eurozone worries, slowing Chinese growth, and global economic health stay on the front burner.  Model shaves 5 points as its technical indicators weaken further.  The pullback low from the current bull market high now stands at 4.6%. 

Frustration with current political leaders was evident in the French and Greek elections, and likely in the coming German election.  France elected a new president, a socialist, which probably means less austerity, more stimulus spending, higher taxes, bigger budgets, and additional national debt.  The debt service in France, the cost of paying interest on the national debt, is second only to the cost of education.  Interest rates to service this debt will rise should France’s debt rating lose another notch, adding to the budgetary burden.  Unless effective market growth policies are put into place to compensate, the French outlook looks tenuous.  France in denial?  Europe in denial?  Or is it growing desperation?  In Greece the neo-Nazi right and far left gained enough electoral votes to deny any party a majority, thus requiring either a difficult-to-form coalition or new elections.  Greek unemployment is about 22%, bankruptcies are soaring, and the stock market has plunged about 90%.  The eurozone would survive if Greece totally defaults and leaves.  World banks have had time to massage their Greek loan exposures and, after all, Greece is small potatoes:  Its population of 11 million is not that much bigger than New York City’s 8 million; its GDP would rank 15th in US states.  Still, there would be financial turmoil should Greece exit the eurozone.  For Greece, the consequences would be severe for a time.  Now, Spain is another order of magnitude more serious;  its GDP is about the same as California’s, our number one state by GDP.  Spanish banks are basket cases.  Most would be shut down in this country based on the ratio of non-performing loans (those in or near default) to bank capital, which are four times the 5% allowed in the US.

And then there’s the specter of contagion.  There is already a run on Greek banks, as citizens try to preserve their savings by sending euros abroad.  If Greece reverts to the drachma, and investors in the other peripheral countries suspect additional exits from the euro, might there also not be a run on Spanish banks or Portuguese or Italian or Irish, as investors avoid denominating their investments in weak national currencies by seeking a stable currency?   Moreover, it’s possible that one or more northern European countries are secretly making plans to reinstitute their own currency, should it be in their best interest to leave the euro. 

Is a monetary union without fiscal responsibilities by its southern members tenable, regardless of how noble the experiment has been?  It looks to me that the eurozone continues its devolution, a slow downward spiral that will end in more tears.  And it will seriously roil world stock markets should part of this frayed fabric tear off.  European banks as a whole are much larger than US banks.  A weakened banking system there would acutely affect world trade, increasing the likelihood of deepening recessions.  This is the pessimistic view.  Some optimism?  In the longer run a partial breakup of the eurozone, such as the southern members leaving, will be healthy overall, but with a lot of peril in the meantime.  Or, the eurozone might be saved if the European Central Bank throws serious money at underwater national banks by printing massive amounts of euros (much, much more than the one trillion that evaporated a few months ago), raising the specter of inflation, a policy resisted by Germany, given its history of hyperinflation following WWI.  For perspective on this fear, in 1923 “the exchange rate between the dollar and the Mark was one trillion Marks to one dollar, and a wheelbarrow full of money would not even buy a newspaper.  The eurozone is worth paying attention to.  Can we avoid this slow-motion crash?

Early last week I added EPV to my portfolio, to allay my fears over Europe.  This investment shorts an index of European stocks from sixteen countries; its daily return is twice the inverse (-2x) of the index.  In other words, a daily index loss of 3%, for example, translates into a targeted gain of 6%; conversely, a 3% gain in the index means a likely 6% loss.  This is a volatile investment that hedges long (invested) portfolios against losses, and so only should be used with the usual caution, as a small percentage of the portfolio (5% in my case), and likely not over extended time periods of many months. 

Last week’s comments regarding overinvested v underinvested portfolios remain relevant.

May 6

Model: 89.2       Cash: 0.0%       Buy & Hold: 9.7%       Standard Timing: 9.7%       Aggressive Timing: 13.4%       S&P: 1369

Market gives up last week’s gains and then some to settle at 1369, marking a pullback of about 3.5% from the April 1419 recovery high.  Friday’s jobs report put the kibosh on the market, as the economy added a disappointing number of jobs.  Although the unemployment rate ticked down to 8.1%, the drop was accounted for by a reduced labor force.  Signs remain mixed on whether or not the economy is faltering.  Adding to worries are Greek and French elections today, which could lead to even more instability should there be leadership changes. 

The model shaved 9 points from last week’s score, as relative strength and trend indicators weakened.  A continued short-term pullback up to 10% or so would not be surprising.  Moreover, market insecurity and instability will likely continue until after the US election, at which time economic policies will be more certain.  The Supreme Court decision on the health care bill by the end of June will be another certainty/uncertainty waypoint.  Portfolios that are overinvested relative to risk could lighten up, given the 10% year-to-date gain and the 28% to-date gain over this buy signal, with reinvested dividends; underinvested portfolios relative to risk might see an opportunity during a pullback to add to stock holdings, while the model remains on its buy signal. 

April 29

Model: 98.3       Cash: 0.0%       Buy & Hold: 12.4%       Standard Timing: 12.4%       Aggressive Timing: 17.8%       S&P: 1403

Our benchmark index jumps 2% to 1403, as the market continues its climb up the wall of worry, not liking the jobless claims, last quarter’s GDP number, and the continuing European situation.  Still, it seems that the market ignored the bad news in favor of the good.  What fanned the market's rise?  How about more solid earnings, increased consumer spending, improved housing data and consumer sentiment, and the underwhelming GDP number as encouragement for those who believe that the Fed will ease some more. And what about France v Germany?  Germany insists on more austerity; France might shift more to the socialist side of the political ledger.  Is France in denial?  Other countries besides Greece are pushing back on the austerity required by Germany: Spain (as its debt is downgraded, again) and the Dutch.  Keep an eye out on a grumbling (crumbling?) European coalition as more fodder for roiling the markets.  Still, European bad news is recognized and likely already built in to prices?  What could really affect the markets is a very surprising fat-tail event such as the sudden exit of Greece or even worse the implosion of the Eurozone.  Very unlikely events, to be sure, which is why we call them Black Swans.

I’m still traveling in some remote areas over the coming week.  The next weekly update might be late.

April 22

Model: 97.6       Cash: 0.0%       Buy & Hold: 10.3%       Standard Timing: 10.3%       Aggressive Timing: 14.7%       S&P: 1379

Volatility continued this past week, although this time the market advanced, to 1379 based on our benchmark index.  The model is steady and strong.  Operating strategy during a buy signal remains the same: buy the dips, for portfolios that are underinvested, consistent with attitudes toward risk.

Quote of the week.  (This article by Professor Odlyzko is a very worthwhile historical read.)

A superpower with crippling debt, exorbitant taxes, glaring inequality, wages far exceeding those of competitors, high and persistent unemployment, lack of basic workplace skills, malnutrition, a rapidly growing rival across the ocean to the West, heated debates about the role of government in the economy, and widespread pessimism about the future. Could that be any country but the U.S. today, with China as the looming threat? Toss in costly military misadventures in the Middle East, Greece unable to pay its debts, a sclerotic domestic legal system clogging up the economy, and the rising competitor flouting copyright and other property rights and relying on slave labor, and the case seems clinched. Yet this is also an accurate description of Britain around 1850, with the United States as the transatlantic rival. Surprisingly, what followed was an explosive acceleration of the Industrial Revolution that saw the UK sprint ahead of others during the “Great Victorian Boom” of the third quarter of the 19th century.

Fast forward.  How about the coming US manufacturing boom, as automated flexible manufacturing technologies powered by cheap energy tilts the global playing field towards the US?  Green is great, with the focus on intelligent conservation, rather than renewable resources that can’t possibly provide the necessary juice, not to mention their much higher cost.  Green energy just does not create enough energy, in our lifetimes.  Let’s use the energy resources we have now, in abundance.  We’re an energy superpower, on paper.  And we can export these energy products as well, refined or not.  And how about jobs?  And how about more tax revenues for states and Washington, through growth not higher tax rates?  And how about cutting the umbilical cord to unstable, unfriendly, energy-rich countries of the world that threaten our economic wellbeing and increase our propensity for military interventions?  We just need the right governmental policies and leadership to make this happen, sooner rather than later.  Yes, environmental issues can be worked out, if not radicalized.

Domestic industrial ETFs include the following: XLI, IYJ, VIS.  For a more complete list check out the ETF Database: Industrials.

I’m traveling in some remote areas over the coming two weeks.  Weekly updates might be late.

April 15

Model: 97.2       Cash: 0.0%       Buy & Hold: 9.6%       Standard Timing: 9.6%       Aggressive Timing: 13.6%       S&P: 1370

Volatility is back as we get three strong down days and two strong up days this past week.  The major indexes lost in the neighborhood of 2% for the week, the worst weekly loss this year, although a ho-hummer based on the historical record; weekly losses less than 2.5% occur about one-third of weeks.  Losses of about 5% take place about four times per year, on average, without entering a bear market.  The S&P pulled back about 4% from its April 2 1419 high, settling about 3% below this high by the end of the week, at 1370.  A pullback in the 5 to 10% range would not be surprising in here, given how far we’ve come this year.  We might even get a fast moderate correction in the 10-15% range, an event that concerns us about every other year, on average.  Last year we had a deep, nearly 20% correction; the year before we had a severe 16% correction.  Portfolios that have missed the train might consider jumping on as it slows, while the model remains bullish. 

Still, caution is warranted with respect to “fully” invested positions, as stated in some previous posts:  All bets are off if the European crisis deepens; it’s looking bad for Spain, as the realities of austerity kick in the smoldering fires of social unrest spawn outbreaks, and the “Masters of the Universe“ (bond traders) get increasingly nervous. “Déjà vu all over again” in this evolving Greek tragedy?

On politics, the economy, and the market.

Well, this is one controversial topic, with opposing philosophies offering “solutions” to our social and economic problems.  That’s why we have two political parties, no?  In theory, informed citizens, more or less, decide through our voting rights the social and economic direction of the country, with the occasional judicial “corrections.”  My perspective, in this post and some subsequent posts, will focus on the economy and the market, rather than social issues such as morality and religion, although social issues, ethics, and the economy are interlinked in many cases, as in national health care, entitlements, immigration, taxation “fairness” and safety nets… and so some degree of social commentary is unavoidable and will be addressed in future posts.  By the way, historically, economics and political philosophy were part of the same field, political economy, a child of moral philosophy or ethics.  Subsequently, political economy branched into economics and political science.  The divorce remains messy.

We’re now into the swing (and punches) of the presidential election cycle.  Which party does the market favor?  While many believe that the business climate and economic progress are more favorable with Republicans in power, the historical record is confused at best, depending on many factors, including the political balance and dynamics within the three branches of government, ensuing legislation and rulings, the point in the business cycle, and worldwide macroeconomic and demographic conditions.  Just looking at the Presidential Cycle without the confounding elements mentioned, Fisher Investments determined the following:

* Third and fourth years of a presidential term are positive for the stock market, based on average returns.

* A switch in presidency from one party to the next is positive for the upcoming year, regardless of party.

* A re-elected Democrat is positive for the next year, whereas a re-elected Republican is negative, on average.

So, it looks just based on these stats that next year should be positive.

From a recent Barron’s article that predicts GOP control of Congress, even if the President is reelected [my insertion]:

GOP control of Congress will likely mean that most individual tax rates will stay where they are, and that Congress and the president may be able to agree on some serious spending cuts and major corporate-tax reforms. Steep reductions in defense spending probably will be curtailed, making this an auspicious time to invest in the sector. Regulations and policies inhibiting the production of domestic oil and gas will be relaxed. And the 2010 health-care bill passed by the Democratic controlled Congress will be repealed [no veto by Obama if he’s still president? Or maybe the Supreme Court takes care of this?].

With Barack Obama's threatened increase in taxes—especially the significant hikes in the capital-gains rates for high earners—no longer in play, the pace of investment and job-creation should pick up, accelerating the rebound in stock and real-estate prices that the administration and the Federal Reserve have been desperately trying to engineer since 2008.

The New York Times offers its own research:

As the presidential election campaign heats up, two measures of the economic success of President Obama’s administration provide drastically different views of how he has done.

His stock market record is among the best of all the administrations that have held office over the last century. But in terms of economic growth, the record is among the poorest.

… since the presidential inauguration on Jan. 20, 2009, the stock market has risen at an annual rate of 16.4 percent, even after adjusting for inflation. That is better than all but four previous administrations.

In general, share prices seem to have had a better record as election forecasters. Nine previous administrations have produced double-digit percentage gains over the comparable period, and the incumbent party won in seven of the subsequent elections, the exceptions being Democratic defeats in 1952 and 2000.

President Obama may be able to take heart from the somewhat similar experience of President Wilson, who was able to claim credit for the recovery and pass off the blame for the recession as he won re-election in 1916.

Not surprising: two different viewpoints based on two polar-opposite media regarding editorial opinions.

Surely getting government debt and deficits under control (over time, not immediately), simplifying (small) business regulations, enforcing the rule of law through financial regulations that curb excesses and “too big to fail,” without unnecessarily hampering market efficiencies based on anti-business populist sentiment, passing meaningful tax reform and common-sense health care and energy policies, and fostering legislation that encourages investment in ongoing businesses, startups, infrastructure, and education are all good for the health of the country’s economy and its citizens.  The government needs to implement policies that favor national savings to facilitate seed capital and investments over policies that encourage the excessive debt and over-consumption that fueled the false prosperity of the last two decades.  More stimulus money should have been used for infrastructure instead of misplaced programs like “cash for clunkers,” which increased consumer debt, robbed future demand and retired many perfectly serviceable vehicles… while providing insignificant benefits to the carbon footprint and a net-net zero for the auto makers and dealers. 

The bipartisan Presidential Debt Commission’s recommendations outlined policies that address these issues, as does the Ryan Plan.  It would appear that the most progress is made when at least some consensus is reached, as in the Reagan years with a Democratic Congress and the Clinton years with a Republican Congress.  Those Presidents knew how to horse trade.  The recent lame-duck Congress did practice partisanship and gridlock, as passionate politicians rooted in the poles of their respective ideologies failed to reach consensus.  Research shows that during “normal” times this is not necessarily a bad thing, as government effectively gets out of the way of businesses doing what they do best, under the rule of law: the reasonably efficient allocation of resources, economic growth and prosperity through innovation and productivity, and the creation of jobs, jobs, jobs, particularly from startups. Think future IBMs, Apples, Microsofts, Walmarts, Amgens, Amazons, Googles, eBays and Facebooks in currently incipient or non-existent technological, manufacturing, service, retail, scientific, communications, medical, and energy sectors, not to mention the zillions of new startups and small businesses we never hear about; don’t think proliferating and gargantuan government agencies with a fraction of the GDP multiplier effect associated with the private sector. 

The 2010 Republican tsunami was surely a response to the poor economy and jobs market… but its scope and intensity also suggest a likely pushback to a sense that the current (and previous) administration and Congress went too far in political direction, on non-transparent and arrogant legislative procedures and executive orders, the size and influence of government, and fiscal irresponsibility. The Federal Government’s spending now accounts for about 45% of our GDP and rising based on current projections (it had been in the 30s for the last four decades).  Will taxpayers continue to fund these excesses and expansions?  It appears not.  Will the bond market vigilantes?  They’re waiting in the wings.

We will need some consensus to at least start the process of solving our vexing problems.  Although my own views favor many Conservative over Progressive solutions, no one philosophy has a lock on the best implementations to solving all problems.  The genius of our Founding Fathers was the creation of a system with the intent of reaching compromises and balances that at least partially benefit just about everyone, including minority views, although slow and often frustrating.  By the way, Canada was on the financial ropes in the 1990s, yet subsequently scored a knockout when its center-left government implemented a number of the Conservative policies suggested above;  the current center-right British administration is in the process of doing the same. 

At any rate, regardless of your views or mine on political issues, the upcoming year in this Presidential Cycle looks OK for the market. Having said that, I listen to what the model tells me.  The model is apolitical, unemotional, neither politically correct nor politically incorrect, but… it’s not clueless regarding political events.  Its indicators do react indirectly to political policies that affect the economy and market.  For example, interest rates have become politicized to the extent that the Fed has become politicized: Not only do artificially low interest rates help the economy (in the short term, at the expense of fixed-income savers) but also lower the government’s debt service, as in paying off our mortgage with a low rate.  Several of the model’s monetary indicators monitor interest rates.  And its technical indicators that measure trends, volatility, and market internals such as volumes, advances and declines, and new lows and new highs themselves react to economic events that are affected by government policies.

More to come… this is quite a decade and quite a year.  The upcoming national election will likely set the tone for years.  Keep the faith.

April 8

Model: 98.6       Cash: 0.0%       Buy & Hold: 11.8%       Standard Timing: 11.8%       Aggressive Timing: 17.1%       S&P: 1398

S&P scales bull market to 1419, then pulls back to 1398 by end of week, as jobs data unexpectedly come in weak and the eurozone crisis rears its head once again.  We might get a pullback this coming week, while investors digest Good Friday’s bad news, opening the door for adding to positions, assuming underinvested portfolios with additional appetite for risk, while the model remains on a buy signal.

On the Eurozone and the market.

Statements by Eurozone leaders going back to 2009 emphasized and reemphasized that Greece would not default or restructure its debt... nor would it leave the Eurozone.  The recent deal gave private bond investors a nearly 50% haircut on their holdings, a restructuring that effectively amounts to an orderly default.  And this so-called new debt has traded at about a 70% discount, meaning the haircut is closer to 85%.  The real question? Will there be contagion?  EU leaders are saying there's no risk to other countries.  Wrong again?  Decades of overspending and borrowing to finance social programs and pensions now require severely painful austerity measures imposed by the EU.  Moreover, Greece's low-growth prospects point to continued recession, indeed a looming depression, and a future inability to repay its debt.  At some point, Europe (Germany & the North Countries) might say “enough,” as the Greek public blames the Germans and Austrians, social unrest grows even further, and they want out of the EU, in what would be a very difficult exit that would surely impact stock markets, although likely not for long. 

 

As to contagion: Spain is unraveling by not meeting its budget deficit targets, unemployment is near 25%, and GDP is in contraction.  Its bond sale went badly last week, meaning either still higher interest rates to finance government or a shortfall in financing with not enough players to buy the needed debt.  Ditto Portugal, even worse.  Italy, while better off than Spain & Portugal, still needs help.  And these are far bigger economies than Greece.  To get deficits under control by reducing their debt-to-GDP ratios, these countries have two options: Grow GDP faster than the growth in debt or reduce debt, or a combination of the two. The former option is not likely in the foreseeable future and reducing debt without aggressive growth policies only increases the chances of a deeper recession... the sovereign debt crisis is far from over.

So, why should our markets worry?  Given the high correlation among global markets, problems in Europe (or China especially, but also India, Brazil, Russia) become our problems, as our problems become theirs.  US banks, by some measures, have around 30% exposure to Europe.  If Europe unravels, we feel the pain as well.  As clearly documented in the celebrated book This Time is Different: Eight Centuries of Financial Folly, Reinhart and Rogoff show that “excessive debt accumulation, whether it be by the government, banks, corporations, or consumers, often poses greater systemic risks than it seems during a boom.”  And systemic risk can lead to fat-tail financial crises.  We saw the consequences in our housing bubble.  We’re now seeing the consequences in Europe.  And currently in the US, look no further than California: It has chosen to let a number of cities enter bankruptcy, meaning a severe disruption of services such as health, police and fire... not to mention reduced wages and workforce.  The recession, along with excessive entitlement benefits, over-regulation, inflexible work rules, over-spending, and high taxes, have brought a once dynamic and innovative economy to its knees in the public sector.  It ran deficits even in good times and well before the 2007-2009 recession.  And the exodus of workers and companies continues as the state imposes and proposes even higher taxes.  This time it’s not different.  For a detailed read see California's Greek Tragedy. 

Still, the private economy of California is a dynamo, its GDP ranking first among states by a wide margin, followed by Texas and New York.  Taking population into account, the state ranked 11th on per capita GDP in 2010, dropping two slots since 2007.  Guess what “state” was numero uno in 2010?  District of Columbia, with more than twice the per capita GDP than #2 Delaware and #3 Alaska.  It looks like the power center of the Federal Government is the place to be.  On a national canvas excessive debt over extended periods eventually deals a blow to the economy as either the business cycle weakens or we have a financial crisis unrelated to debt… and consequently impacts the stock market.  Unfortunately, the current trajectory of debt and deficits for the US point to potential future problems.  And far too many people are in denial, or don’t believe it.  They need to set their gazes across the pond.  True, we’re not Greece, we still have a flexible economy and huge growth capabilities, but we do need to make structural changes in our budgets, tax codes, regulations, and national health care.  More to come…

The model dealt reasonably well with the 2008-2009 crisis.  The future?  We’ll see…

April 1

Model: 98.9       Cash: 0.0%       Buy & Hold: 12.6%       Standard Timing: 12.6%       Aggressive Timing: 18.4%       S&P: 1408

The first quarter ends on a positive note, with the Dow up 8%, the S&P 12%, and the Nasdaq 19%.  These are the largest percentage first-quarter increases for the Dow and S&P in 14 years, during the super bull of the 1990s; 21 years for the Nasdaq. The S&P extends its current bull market to 1417 or 109%, before easing back to 1408.  It’s now 10% below its all-time high.  As usual during a buy signal, the operating strategy is to buy the dips, for underinvested portfolios with tolerances for additional risk.

On the economy and the market. 

The market is widely viewed as an anticipatory, although imperfect, mechanism for the economy, based on investors’ perceptions and outlook regarding trends in jobs, housing, oil and gas prices, inflation, monetary policy and interest rates, the health of financial institutions, levels of private and public debt, government deficits, national growth here and abroad, consumer confidence and consumption, global corporate earnings, technological innovation, tax policies, health care legislation, and geopolitics.  And I’ve probably left out some factors.  One thing is clear: all taken together it’s unclear, muddled.  Let’s look briefly at some positives and negatives.

What’s to like.

The U.S. added more than 200,000 jobs, on average, over the last six months, showing gains across industries and demographic groups; the headline unemployment rate is down to 8.3%; weekly jobless claims are at the lowest level in four years.  Housing starts have turned up and mortgage interest rates are low.  Banks are lending more and consumers are spending, as household debt grows.  Consumer confidence is up and sales at U.S. retailers rose at the fastest pace in five months in February, as spending increased at auto dealerships, gas stations and clothing stores.  The rate of increase in manufacturing output has doubled over the past six months.  GDP is increasing at a 3% rate, above forecasts.  Global banking systems and the Fed continue the injection of liquidity, which augurs well for stock markets and commodities.  The “official” inflation rate remains tame, at about 3%.  Financial institutions are healthier according to recent stress tests.  First-quarter profits for the Standard & Poor's 500 were up 13%.  And we’re in a bull market that keeps printing new highs.

What’s not to like.

At the beginning of the last decade unemployment was half what it is today, at about 4%, which is considered “full” employment.  To get back to this rate we would have to add jobs at a much faster pace.  According to John Mauldin, we need to create 125 thousand new jobs a month just to keep up with population growth.  If we keep up the current pace of job growth (not easy), we could get back to full employment in four to five years, a not so short time frame.  Housing prices continue their decline, although at a slower rate.  Prices are at levels last seen nine years ago, according to the Case-Shiller Home Price Index.  And Gen Y young adults (the under 30 “millenials”) are not likely to take up the slack, as they pay off college debts and view homes as poor investments. 

Yes, banks are lending more and retail sales are up, but so is consumer debt, which takes a bigger slice of the pie than corporate debt.  For better long term economic health, it's better to de-emphasize consumption and substitute capital investment by corporations and government expenditures for infrastructure and education.  Best for credit to flow from those who consume to those who produce. This doesn't happen when it's more profitable for a bank to loan to consumers than to businesses. Balance is needed, of course, but generally capital invested in business promotes jobs, giving workers real money with which to consume, rather than consuming through borrowed money.  Moreover, if debt gets out of hand again, consumers will get in trouble when interest rates inevitably rise after Bernanke (“Helicopter Ben”) lands his money-dropping chopper.  Inflation-adjusted after-tax income, the fuel for consumer spending other than borrowing, has barely risen in the past six months. 

Energy prices will likely remain high for the near term.  The summer driving season and more expensive summer gasoline blends are coming.  And according to a recent International Energy Agency Report current global oil demand exceeds global supplies by about 600 thousand barrels per day, putting pressure on prices.  Note also that releasing oil from the Strategic Petroleum Reserve is more of a political than economic move.  Last year’s release affected prices for a couple of days; one month later prices were up about 10%.  To add insult to injury the oil was likely replaced at a higher cost. Let’s save that act for its intent, a true crisis, such as the fat-tail event war in the Middle East.  As more supply comes on line over the coming year(s), however, prices should moderate.  I have a small position in DBO to account for higher oil prices and as a hedge to a serious oil crisis. (Also see last week’s post.) 

Unofficial inflation rates are higher than those reported, as the government has refigured its calculation to look better than it actually is, quality improvements as part of the rationale.  For example, we might pay more for a particular vehicle, but accounting for better quality might render the cost less when calculated for inflation purposes.  It’s still an increase in out-of-pocket cost, no?  If calculated by former CPI formulas the inflation rate would be closer to 10%, not 3%.  And the very easy monetary policy of the past few years could inflame the official rate sometime in the not-too-distant future (as the economy picks up).   ETF flows suggest near-term inflation worries.  I have a small position in GLD as a classic inflation and geopolitical crisis hedge.  Treasury Inflation Protected Securities (TIPS) would be another; see TIP, for example.  By many accounts Treasury bonds are in a bubble due to extremely low interest rates and the risk-off trade.  I also own a small position in TBT to account for an unwinding of the bubble, as interest rates increase from an improving economy, additional inflation, and greater confidence in equities and other asset classes (risk-on trade). 

Lower GDP growth in the 2% neighborhood is anticipated, as cuts in spending by the federal government and by state and local governments continue their drag on economic growth, and tax increases and spending cuts loom at year-end unless Congress and the president find a face-saving or deficit-reducing compromise before then.  Moreover, the European crisis is far from over, adding another potential drag on global growth and our exports.  And financial institutions remain “too big to fail,” suggesting that the next financial crisis will require bailouts (again), giving credence to the criticism that what we have is socialism for the few and capitalism for the rest of us.

And then there’s the specter of government debt and obligations, along with the inevitable continued unwinding (deleveraging) of the Great Debt Supercycle.  And the uncertainty over political elections (and directions) here and in Europe.  And needed  tax policy changes.  And the cost, controversy and uncertainty over how to deliver national health care.  These are complex and controversial topics that I’ll take up in future posts under the eurozone and political commentaries. 

So, are we confused yet?  It looks like the negatives outweigh the positives. Who knows how these issues will play out over, say, the next year or two.  No wonder the market is so turbulent, although it has continued up that “wall of worry.” Rather than stressing out trying to figure this stuff out I mostly rely on the model to guide my macro investments.  And it’s not like the model ignores these issues.  Its technical indicators react to the market’s consensus and detects excesses, its sentiment indicators measure emotion from a contrarian perspective, its monetary indicators assess monetary policy and interest rates, and its fundamental indicators address aggregate corporate valuations.  The model stirs this potentially toxic brew and makes its judgment.  It tastes pretty good for now. That will do for me.

 

Note:  Four pdf files have been added to the downloads screen: data and graphs for tested and live time series.  See menu at left or bottom of page.

March 25

Model: 98.8       Cash: 0.0%       Buy & Hold: 11.6%       Standard Timing: 11.6%       Aggressive Timing: 17.0%       S&P: 1397

S&P 500 extends bull market to 1408 on Monday, 108% above the 677 bear market low in March, 2009, then eases back to a 1397 Friday close.  Year-to-date gains look good as the model remains solidly bullish.

On the economy and the market: Energy prices. 

So, what’s it costing you to fill up your gas tank these days?  High oil prices in general and gas prices in particular raise the issue of damaging the economy (and by extension the stock market and our investments in private, public, and retirement accounts), threatening US and world growth.  Why so high recently? The short answer:  It’s a closing gap between demand and available supply, coupled with geopolitical fears that promote speculation.  Consider the increasing demand by emerging nations such as China & India; Japan's shift from nuclear to oil (and liquefied natural gas) fuels; instability in oil producing nations such as Sudan, South Sudan, Yemen, Iran, Libya, and Nigeria; and the Iranian threat to disrupt oil shipments through the Straits of Hormuz.

Intermediate and longer term solutions include: continued conservation and greater efficiencies on the demand side; on the supply side, the additional expansion of energies such as wind, solar, biomass/biofuels, nuclear, and, yes, domestic and Canadian supplies of oil and natural gas from both private and Federal sources. Oil is not going away in our lifetimes, so why not enthusiastically encourage supply from our friendly neighbor and our extensive domestic reserves, while at the same time increasing national security, providing a significant number of high-paying jobs, and stimulating the national economy with money flows that would otherwise mostly go to either unfriendly or unstable countries. Exporting supplies and refined products would help the economy as well. The US is energy rich and should gradually achieve energy independence given the recent discoveries of huge shale gas and oil fields, coupled with the political leadership and commitment to exploit these resources, with reasonable safety precautions.  Moreover, there’s another potential and significant benefit for the US economy:  Low-cost energy relative to the rest of the world coupled with manufacturing innovations in flexible-automation should shift the dynamic of manufacturing locations from countries with cheap labor to countries with cheap energy.  Additionally, this would lead to improvements in our trade deficit, since energy imports account for roughly half of this deficit.  Check out a preview of an upcoming energy report.

Yes, we should rightly be concerned about the environmental consequences of fossil fuels.  True, a proven, potential and realistic downside of using carbon-based fuels is damage to the environment, although these problems can be mitigated (not eliminated) by careful, not obsessive, regulations and safeguards. For example, the problem with contaminated ground water when fracking natural gas appears to be not the fracking process itself but the integrity of the wells, a problem that's solvable.  Likewise with the new procedures and regulations in place since the recent Gulf oil spill, as long as they’re supervised and enforced. And is the man-made climate change fear overhyped?  Take a read from a recent letter put out by some prominent scientists.  Is the climate-change orthodoxy wrong and self-serving?  Orthodoxy and rigidity in research universities and institutions are surprisingly common, which I have often seen (and practiced myself) over thirty-six years as a professor and researcher.  And there are unintended consequences from using renewable energy.

Do we need to demonize fossils by renewables proponents?  Do we need to demonize renewables by fossils advocates?  Can we have an objective, honest dialog?  In the final analysis it’s a tradeoff between damage to the environment and damage to the economy, and by extension the well being of our citizens, both our medical health and our economic health… Jobs or the environment?  Balance is needed, but what’s the right balance?

It’s argued by environmentalists and the green lobby that a focus on renewable energies such as biomass, solar, and wind are the wave of the future: inexhaustible energy and jobs to provide it, with no environment v jobs tradeoff.  Moreover, it’s a solution to the inevitability of “peak oil,” that is, an exhaustion of this resource.  That very well may be, but when is the “future?”  Certainly not over the next ten years.  Thirty years?  Fifty years?  Peak oil theorists have been wrong for decades that we would run out of oil in the near future (see Daniel Yergin’s book)… and wrong even more so now with the latest discoveries and advanced extraction technologies.  By some estimates we have a 200-year supply of the natural gas resource.  And can these renewable options replace the huge generating capacity of carbon-based fuels?  Apparently not anytime soon, not even close.  In 2009 renewable sources accounted for about 8% of our energy needs.  Wind about 1%; biofuels less than 2%;  solar far less than one percent.  Hydropower, wood, and biofuels accounted for about 80% of the overall renewable eight percent.  And then there’s cost, a complex calculation that can include factors such as investment, fuel costs, subsidies, taxes, disposal, CO2 capture, and time frame.  Cost estimates for electricity from various technologies, different methodologies, and several sources look good for natural gas and land-based wind.  Cheap and recently plentiful natural gas is already causing a building boom in generating plants that otherwise might turn to nuclear or coal.  And there appears to be a greater commitment to converting our trucking fleet from diesel to liquefied natural gas. Let the market decide.  It’s much better at allocating resources than government technocrats.  Capital will flow to the most efficient resources, over time, and within the context of more streamlined permitting processes and regulatory certainty and enforcement.  And it will cost less to fill our gas tanks… or to charge our electric cars.

By the way, the model does not account for energy, oil or gas prices directly; their consequences are felt by some of the model’s technical and sentiment indicators.  I will, however, explore a more direct relationship for the model’s 2013 revision.  And energy is one of my long-term investment themes.  I currently own an oil ETF (DBO) and energy equipment and services ETFs (XLE & VDE).  I’m also in the S&P 500 ETF (SPY), which seeks to replicate the performance of the model’s benchmark index and  includes about 12% energy investments in its makeup.

March 18

Model: 99.1       Cash: 0.0%       Buy & Hold: 12.2%       Standard Timing: 12.2%       Aggressive Timing: 17.9%       S&P: 1404

Bull market extends to S&P 1404, crossing the 1400 milestone for the first time since May, 2008.  Still, the index remains 10% below its all-time high of 1565 in October, 2007 and just 8% under the twin and slightly lower peak of 1518 in March, 2000, a long and volatile twelve-year span that included a bear-market low of 677 in March, 2009, a devastating 57% below the peak over a 17 month time span that experienced the brunt of the financial crisis.  The Nasdaq Composite finished above the 3000 level for the first time since December 2000.  At that time it was on its way down from its historic peak.  Now, twelve years later, it's on its way back up that mountain, although still a whopping 40% below its bubble-summit.

On the current bull market. 

First, some relevant stats.  We’re now 36 months and 107% into a cyclical bull market, following the twin cyclical bears that stole 57% from S&P 500 portfolios over the period October, 2007 to March, 2009 (there was an intervening cyclical bull lasting two months).  The age of a median bull market based on the S&P 500 is 44 months, a metric that says half the bull market lengths were above it and half were below it.  The range is 2 to 147 months, the latter an outlier and reflection of the mega-bull that ran from  December, 1987 to March, 2000, with a gargantuan 582% gain.  The median gain stands at 101%.  Runner up was the 85-month, 263% bull from 1949 into 1956.  Since 1929 there have been 16 bear markets and the current 16th bull market.  Of these, half were longer than the current bull and 44% had larger gains. 

Is the current bull “long in the tooth?”  Not based on the historical record, as it’s in the middle of the pack when looking at length and return.  To reach the previous all-time high this bull would have to run it up 131% from its present 107%, or another 11% from its latest close. Should investors who missed the bull be jumping in now?  Should those of us who benefitted be “taking money off the table?”  Let’s look at some additional thoughts and stats.

Fear and greed, our emotions, cause far too many investors to mistime the market.  Multiple studies by Morningstar, TrimTabs, and Investment Company Institute clearly show that the largest net funds flows into stock funds occur near market tops, as investors who had been out of the market feel comfortable enough to get back in (greed and regret); conversely, the largest net outflows are near market bottoms, when investors are most fearful.  Many investors are essentially buying high and selling low, the reverse of what should be, exhibiting the human tendency for risk aversion when fearful, and less so when not.  Many, many investors have missed out on the current bull market.  And it’s not surprising that investors have not participated out of fear, given the “lost decade” from 2000-2009, a cumulative 9% loss over ten years with reinvested dividends (24% without dividends), and volatility not experienced since the 1930s. 

This is why we need a good timing model that, in theory at least, tones down the emotions by basing investment exposure on historically proven analytical results over long time periods.  During extended bull markets a good timing system will capture most, but not all, of the gains; over extended bear markets it will avoid most, but not all, of the losses.  In our case, the “proof is in the pudding,”  as the model returned a cumulative actual (live) 58% for the standard strategy and 84% for the aggressive variation during the 2000s, versus a cumulative 9% loss for buying and holding during the entire decade.  And the cited loss would be a kind statistic if we were to account for the buying high and selling low phenomenon cited in the previous paragraph.

If we’re currently out of the market should we buy in?  Yes, at least some, with the model on a buy signal.  Should we get out if we’ve been in? No, at least not entirely, with the model on a buy signal.  To what extent we’re in or out depends on our need for return and tolerance for risk, which itself is influenced by our personality traits, whether we’re in, near, or far from retirement, and our sources of other income and lifestyle.  As for me: I’m retired, the portfolio is a major source of funds, I don’t especially live on the cheap, and I have a decent tolerance for risk with a reasonable dosage of caution.  I’m currently 55% in equities, 5% in commodities, and 10% in bonds, with the remainder in cash.  All investments are in ETFs.

Investing in stocks is certainly not for the “faint of heart.”  We have to accept the bad (risk, fear) along with the good (return, self interest).  The model helps me with the fear part and has ensured pretty good returns.  That’s why we use measures that adjust returns for risk, risk-adjusted returns, to better compare different time periods and alternative investment classes… and to account for our propensity to avoid risk. 

By the way, the fourth year of a bull market has generated an average 19% return.  And last year we came within a hair of a bear market, which means that some of us could  arguably say that the current bull market is younger than the official consensus?  This bull market will end, of course, although in the near future it will probably need a serious turn for the worse regarding the economy, the eurozone, and political policies.  These topics are the subjects of future postings.  Bull markets climb the proverbial “wall of worry.”  When the wall comes tumbling down from over-optimism is when we actually do need to worry.  And remember that the model does not seek to detect bull or bear markets; rather its mission in life is to identify whether the just-ended week is an inflection point, a turn in the primary trend.  Bull markets do include 85% of the primary uptrends in the model’s historical data base.  The model keeps a finger on the pulse of the market patient, so hopefully it will detect when it's time to bail.  And all bets are off if we have a completely unknown negative Black Swan.

March 11

Model: 99.0       Cash: 0.0%       Buy & Hold: 9.4%       Standard Timing: 9.4%       Aggressive Timing: 13.8%       S&P: 1371

A bit of volatility came back into the market this past week, as the S&P pulled back about 2% from its recent high, then clawed back to 1371, just above even by the end of the week, and just 3 points below last week’s bull-market high.  The model remains unperturbed, happy with its gains so far this year.  Do we continue along our merry way?  Or are we in denial that this party will end soon?

To address these questions I’ll give you my thoughts over the next several weeks on each of the following (interrelated) issues, one or more postings per topic.

  • On the current bull market.  Is it long in the tooth, or how long and how high can we go, now that it’s three years old?  Is it too late to get in? Should we be thinking of getting out?
  • On the economy and the market.  What concerns should we have regarding jobs, housing, oil/gas prices/Iran, inflation, monetary policy/interest rates, debt supercycle/deleveraging, earnings, domestic & global growth?
  • On the Eurozone.  Too many promises, too much debt, too little growth, too late?  Is Greece fixable?  Are other peripheral countries next?  Effect on global economy?  Domestic economy?  Are we looking at ourselves in the future? Is this time different?
  • On politics.  Is market performance determined by which party is in power?  Which party wins an election? Is gridlock bad for the market?  How about policies regarding debt and deficits, entitlements, the military, regulations, taxation, jobs, health care, education, infrastructure, energy? 

Ok, this is much more than a handful for these postings, overly-ambitious, the subjects of books and long articles.  But I will try to keep it short and relevant with respect to the market, more like executive summaries.  Some of the points will be based on analyses and the historical record; others on opinion.  Be warned:  As with any writer or commentator, interpretations of “reality” are filtered and distorted through personal prisms, our experiences, beliefs, and emotions... and what we choose to leave in or out from the narration. Still, the model remains my compass, impassionate, imperfect, a reliable old friend, the best I have.

March 4

Model: 99.0       Cash: 0.0%       Buy & Hold: 9.3%       Standard Timing: 9.3%       Aggressive Timing: 13.6%       S&P: 1370

S&P extends bull run to 1374, before pulling back to 1370 on Friday.  The model remains exceedingly bullish.  To summarize its indicators: technicals such as risk-adjusted trend, momentum, advances v declines, percent lows, new highs v new lows, up v down volume, and the VIX (a measure of volatility) are all very positive; monetary indicators regarding interest rates, their spread relationships (differences among various types of rates), and money supply are also very bullish; sentiment measures are neutral, with a balance between bulls and bears and neutral cash holdings by mutual funds (although investors themselves are holding a lot of cash, a bullish contrarian sign); and fundamentals such as dividends relative to treasury bills and prices v earnings and dividends show strong readings. 

In reality, none of the model’s four broad components (technical, monetary, sentiment, fundamental) are maxed out.  And, yet, the model’s reading at 99 (out of 100) appears to be just about at its absolute high.  So, why the apparent inconsistency?  The model’s mathematical behavior is not linear, but rather non-linear and what’s called asymptotic (its score is a curve that slowly approaches but never touches 100, with the mirror image to zero also the same).  The model’s changes are very small near each extreme (100 and 0), but changes are sensitive within the range 20 to 80.  If you feast on numbers (you “quants” out there), take a look at the downloadable data and note that, within the sensitivity range mentioned, the model’s score can change dramatically, increasing the likelihood of a switch signal. 

Given these insights regarding the model, we can say that it’s not likely to change its tune anytime soon.  Underinvested portfolios willing to take on additional risk should feel relatively confident in deploying additional funds to the market, given an intermediate time horizon (in the short term the market appears overbought and possibly due for a minor pullback).

February 26

Model: 98.9       Cash: 0.0%       Buy & Hold: 9.0%       Standard Timing: 9.0%       Aggressive Timing: 13.1%       S&P: 1366

It took almost a year, a volatile, frustrating year for the bulls; a year that included a near-bear market last October.  Yet, the S&P 500 finally reconfirmed, just barely, the cyclical bull market that peaked last April.  At 1366 our benchmark index has doubled, at 102% above its start, the bear-market low of 677 in March, 2009.  A cause for celebration?  Yes, although let’s not uncork too many champagne bottles.  The index remains 13% below its 1565 secular, all-time high in October 2007, nearly 4 ½ years ago.  This bull market is 36 months old, about 8 months younger than the median bull market, and at the median gain. 

So, what does the model say?  The model says nothing about bull markets, not directly anyway.  Its concern is:  “Does the evidence this past week suggest that we remain in the current primary trend, an 8% or more change over at least eight weeks based on Friday closings? Or does it look like the primary trend has reversed, a so-called inflection point?”  Based on its current score, the model estimates a 99% probability that the primary uptrend remains in place.  And note that primary uptrends are more likely during bull markets than during bear markets, 85% to 15%. These are odds that have served me well over twenty-two years of actual use. 

February 19

Model: 98.9       Cash: 0.0%       Buy & Hold: 8.5%       Standard Timing: 8.5%       Aggressive Timing: 12.6%       S&P: 1361

Rally continues as the S&P 500 settles at 1361, just short of the 1364 cyclical bull high from last April, a goal already achieved by the Dow and Nasdaq.  So, given all the negativity and reasons why the market will not do well, why are we in rally mode?  First, outcomes to the concerns in the January 29 posting may not be as unfavorable as expected.  Second, the US economy appears to be slowly mending: consumer credit is expanding; housing and jobs numbers are improving; corporate profits remain strong; capital goods orders have jumped to pre-recession levels; interest rates remain low; growing investor confidence might encourage an expansion of price/earnings multiples, currently below historical averages; a decade of poor performance has reset valuations at affordable levels; companies and portfolios are stuffed with cash and need more confidence to deploy it; money flows into US stock mutual funds are growing, including redeployments from Europe to the US.  Moreover, the model remains extremely positive, suggesting a healthy market that’s in an uptrend.  And all of this given the business uncertainty over the impact and cost of a looming health care program, possible new taxes, the lack of energy legislation regarding the expansion of domestic oil and its implications for energy prices and national security, and what looks like overdone Federal regulations, current and upcoming. The US economy is indeed resilient.  As usual there will be pullbacks and corrections based on unfavorable news and fears.  Underinvested portfolios should use these to commit more funds to the market, consistent with risk profiles, and while the model is on a buy signal.

February 12

Model: 98.2       Cash: 0.0%       Buy & Hold: 7.0%       Standard Timing: 7.0%       Aggressive Timing: 10.3%       S&P: 1343

Weekly gains evaporate on Friday as the Greek crisis rears its head once more and the country unravels both economically and socially.  The prognosis looks bleak.  Is the market pricing in the risk of a Greek default and possible eventual exit from the eurozone?  If we have an exit, will there be time for an orderly transition?  The market and model remain sanguine.  See the revised FAQ on fat tails, endogenous risk, efficient markets, and relevant books as good reads.

February 5

Model: 97.2       Cash: 0.0%       Buy & Hold: 7.2%       Standard Timing: 7.2%       Aggressive Timing: 10.5%       S&P: 1345

Rally continues as the  Dow & Nasdaq extend their bull market peaks from last April and the S&P at 1345 jumps to within about 1% of its 1364 cyclical bull, also last April.   The Nasdaq now stands at an eleven-year high, yes impressive, but for perspective it remains 42% below its secular (and bubble) peak in March, 2000.  No complaining, though, as it has gained an impressive 160% since its October, 2002 low.   Respective gains for the Dow and S&P sit at 96% and 99% since that low.  The actual (live) standard and aggressive timing strategies over the same time period (October, 2002 to now) show gains of 103% and 92%, respectively, with about half the risk of the S&P.  The standard strategy over this time horizon slightly bests buy and hold, but more than doubles the risk-adjusted return.  Why is this important?  Because risk (fear) affects real-world investing, which when coupled with the desire for return (greed) or regret missing rising markets, clearly shows through Morning Star studies that investors significantly underperform the buy-and-hold strategy: selling when fear is high (near bottoms) and buying when greed or regret is high (near tops).  In other words, buying and holding is rarely practiced, as it requires disciplined and unemotional investing that goes out the window when fear and greed interplay. The benefit of a reliable timing model, assuming its signals are followed, is unemotional discipline.

Another key advantage of a good timing model is the avoidance of severe declines that devastate portfolios, so-called capital-preservation strategies.  Consider the bull-market peak for the S&P 500 in March, 2000.  From that high until now, twelve years, an S&P portfolio advanced just  10%, the consequence of a “lost decade” with four bear markets.  The live standard strategy gained 82% over this time period, while the live aggressive strategy popped 106%.  Reread the last sentence: 10 v 82 v 106%.  During extended bull markets with little or no intervening bear markets, as in the 1980s and 1990s, even good timing strategies tend to lag buy and hold, the consequence of some mistimed switch signals; not so when capital preservation becomes critical.  And, as a bonus, we don’t experience fear when we’re on the sidelines in declining markets.  Yes, we do experience fear at a scary buy signal or regret if we’re late buying a bottom or early selling a top.  Imperfection is part of modeling, part of any good timing strategy.  What counts are the ending dollar amounts of portfolios when comparing alternative investment strategies.

January 29

Model: 95.7       Cash: 0.0%       Buy & Hold: 4.8%       Standard Timing: 4.8%       Aggressive Timing: 7.1%       S&P: 1316

S&P and Nasdaq eke out gains for the week, their fourth straight weekly advances; the Dow breaks its three-week winning streak with a slight loss.  The model continues to assert the strength of the current primary uptrend.  The usual strategy while the model is on a buy signal is to buy the inevitable dips, for underinvested portfolios that can deal with market volatility.  Speaking of volatility, the market has been quiet this new year, so far, even as it shows encouraging gains year to date. 

Risk in the form of volatility, an erratic market, will be back, as conditions remain that caused last year’s swings: In the US, high unemployment, mired housing, sluggish growth, political uncertainty; the European crisis, with its over-the-top sovereign debt and bank insolvencies not supported by economic growth, and officials that fail to take dramatic steps that will mitigate, but not avoid, negative consequences; and suspicions that emerging economies (in particular the BraziRussialndiaChinas) may not pick up global economic slack.  And globally: Continued deleveraging as governments, corporations, and individuals reduce the extreme debt hangover of the past decade, thus further hampering growth, especially in the absence of structural reforms regarding taxation, wages, benefits, and regulation.  Actual or perceived progress or the lack thereof regarding these issues will cause market swings.  They will be resolved, eventually, to be replaced by others, hopefully less dramatic than the current.  The best case scenario for now is that we muddle-through; the worst outcome is that we slip into another severe recession.  Worse yet? A negative black-swan event.

As we know, there’s always risk in the market.  To mostly avoid it invites portfolios that will significantly underperform over long time periods.  Fear after the 1987 crash is what motivated me to develop the model.  It’s served me well since its implementation in late 1989.  I always have a stake in stocks while it’s on a buy signal; I’m always out or somewhat short the stock market when it’s on a sell signal.  As stated before, I’m currently cautious because of my concerns over extreme tail risk.  Many of you have asked about my current positions, so here goes:  40% equities (S&P 500, Nasdaq 100, biotech, high dividends ETFs), 10% commodities (gold, oil, energy services ETFs), 10% bonds (corporate and Treasury ETFs), 40% cash (under the money market and T-Bills electronic mattresses).  Loose buy targets under “normal” circumstances are 50% equities, 20% commodities, and 15% each bonds and cash.

January 22

Model: 95.1       Cash: 0.0%       Buy & Hold: 4.7%       Standard Timing: 4.7%       Aggressive Timing: 6.9%       S&P: 1315

Market advances third week straight, as the S&P marks 1315, nearly 20% above the 1099 October pullback low and just 3.5% below the 1364 cyclical high from last March.  Still, the index sits 16% below the 1565 all-time high in 2007.  The mood seems to have brightened some on Wall Street:  Economic and earnings reports are looking ok on balance and, for a change, we had a quiet week from Europe, although the current “fix” is far from solving the crisis… more on that in a future posting.

The web-page revisions for the 2012 model are ready.  Click menu items at left or at the bottom of the page for specifics.  A question on external events and black swans has been added to the FAQ.  The data file in the Downloads page is also updated.  Use this file to (1) view the model’s optimized timing decisions over the 1970-2011 time span, (2) view the live models timing decisions over the years 1990-2011, and, for you propeller heads out there, (3) add indicators along with the given model scores to develop your own  model variation...  and please let me know if you show improved results over mine for a portfolio that runs from 1970 to 2011.

January 15

Model: 92.3       Cash: 0.0%       Buy & Hold: 2.6%       Standard Timing: 2.6%       Aggressive Timing: 3.8%       S&P: 1289

Despite the usual global woes, our benchmark index advances to 1289, extending the primary uptrend from last August and landing just 5% below the cyclical bull market dating back to March last year.  Recall from the model’s description that primary trends are defined as 8% or more changes over at least eight weeks based on Friday closings.  Their confirmations  through any given just-completed year are important for accurate model updates, a process just completed for this year’s model.

The model that will be used for the remainder of this year is now operational.  Its score for the current environment is a bit lower than its predecessor.  It’s tuned to be slightly more sensitive as well, averaging 1.4 switches per year vs 1.1 previously, while improving overall risk and risk-adjusted return.  It stays invested 68% of the time, less than last year’s 70%.  And it adds two new predictors, one based on a bond interest relationship and another regarding the relative strength of the S&P 500.  The web page revisions for the new year should be ready by the next posting.

January 8

Model: 90.5       Cash: 0.0%       Buy & Hold: 1.6%       Standard Timing: 1.6%       Aggressive Timing: 2.4%       S&P: 1278

Good start for the year, as the S&P 500 gains 1.6% to 1278.  Look for a Friday close above 1285 as a reconfirmation of the model’s primary uptrend that began last August and a possible breakout above 1364 over the next several weeks or months, corroborating an extension of the cyclical bull market that began in March, 2009.  But… expect continued volatility, as the issues that were responsible for last year’s turbulence are not going away anytime soon.

Still working on the revised model for this year.  Hope to have it ready for the January 15 posting.  Note the new archive section below for past postings. 

January 1

Model: 95.1       Cash: 0.0%       Buy & Hold: 0.0%       Standard Timing: 0.0%       Aggressive Timing: 0.0%       S&P: 1258

The last week of the year ends with a whimper, but we managed to eke out a gain of about 2% on the S&P 500 for 2011 during a very volatile and scary year.  At 1258 the index actually ended almost exactly (0.04 lower) where it started the year, the total return solely due to dividends.  The aggressive strategy lost about 2%, as did the Nasdaq.  The Dow gained about 8% with reinvested dividends.  T-Bills were at about 0%, the electronic version of money under the mattress.  Some commodities fared better: gold up 10%, oil up 8%.  The big winners in the flight-to-safety stampede: Thirty-year Treasuries surged about 35%; the ten-years about 17%.  A diversified portfolio with long Treasuries and some commodities paid off this past year.  Expecting another bumpy ride in 2012.

The model’s performance disappointed by not standing aside during the nearly 20% seventeen-week severe correction from April into August, with the steepest declines over the last four weeks.  Still, by not bailing during the selloff, it paid to stay in as the market recovered in subsequent weeks, establishing a new primary uptrend.  Fast, steep declines are always troublesome for models with intermediate to long-term outlooks.  We’ll see if the revised model for 2012 does a better job, with hindsight and without sacrificing prior performances.  Look for the updated, re-optimized model by mid-January.  Meanwhile…

Best Wishes for a Healthy, Prosperous, and Happy New Year

 

ARCHIVE

2011

2010

 

 

NOTE

The TimerTrac link at left is a free report provided by an independent company that tracks the performance of market timers. Note that the report does not account for dividends and their reinvestment, as we do, and as would be the case for reported returns in the media, thus showing lower returns for both buy-and-hold and the standard strategy during buy signals than those seen under the live performance table in our Reality Check page.  This is a significant difference in cumulative returns over long time horizons as reinvested dividends make up 30 to 50% of S&P 500 total returns, depending on the chosen time period.  Also note that the timing model is a statistical mathematical model that issues buy and sell signals.  The strategies (standard & aggressive) are the trades that are made when these signals are issued. 

Distribution
Copyright © 2012 Richard Mojena. All rights reserved. All materials contained on this site are protected by United States copyright law and may not be reproduced, distributed, transmitted, displayed, published or broadcast without the prior written permission of Richard Mojena at mojena.com. You may not alter or remove any graphics, copyright or other notice from copies of the content.  You may download or print one machine readable copy and one print copy per page from this site for your personal, noncommercial use only.

 

Disclaimer

Specific and personalized investment advice is not intended by this communication. Its contents are for the public record as a free public service. Information is based on the analysis of past data and assessments by the models. Future performance may not reflect past performance. Profitable trades are not guaranteed. No system or methodology ensures stock market profits. No guarantee is made regarding the reliability or accuracy of data. In other words, use this stuff at your own risk!

Front Page      Timing Model      Reality Check      FAQ      Downloads      About      Mea culpa?

mojena.com

As is, no spin