March 20th, 2013
The second most difficult challenge (after auguring the market’s future near-term direction) is to select the best stocks into which to put some money to work so as to maximize potential returns while keeping risk of loss acceptable. Most of the time, whenever you hear or read a comparison between two stocks, “talking heads” like Jim Cramer usually throw out such slogans as “buy best of breed” as the guide in making your choice. However, although “best of breed” is subjective and is boiled down fundamental factors like sales and earnings growth, great management or higher profit margins. Seldom does Technical factors such as stock volatility, institutional support or relative strength seldom enter a “best of breed” discussion.
For example, on January 26, 2012, Cramer’s theStreet.com had a piece on XLB, the basic materials ETF in which they claimed that “DuPont Company (DD) is the undisputed king of basic materials. From the 2009 rally, DuPont was the top performing Dow component.” However, PPG (PPG) wasn’t mentioned at all. PPG represented only 4% of the ETF as compared with DD’s nearly 10%. But which was actually the better stock to have bought more than a year ago. A comparison of the two shows that PPG actually appreciated 58% while DD declined nearly -3% (click on images to enlarge).
I’m now sitting on some cash trying to figure out if I should redeploy it in yesterday’s momentum stock leaders (who are still advancing nicely) or taking a gamble on stocks that have great charts and look like they may soon breakout and become tomorrow’s leaders.
In technically-based comparison like these, IBD’s rule is to only buy stocks that are within a few percentage points above what IBD labels their “buy point”, those breakouts or crosses above resistance trendlines which are top boundaries of a variety of chart patterns such as inverted hear-and-shoulders, ascending triangles or IBD’s cups-and-handles. This comparison might match up LKQ (automotive parts), a stock that’s advance 370% since 2009 in a near straight shot and, perhaps, may continue to advance higher against, for example, Williams-Sonoma (retail home furnishings).
Putting aside fundamentals and basing the investment choice strictly on a technical basis, the choice rests on how one evaluates two factors:
- Trading off the risk one perceives in buying a stock continuing to advance after having nearly doubled in each of the past four years vs. the risk that a stock will continue to languish for continued economic sluggishness.
- How important the psychic reward might be for you to have found a new “high flyer” before others vs. piggybacking on a winner that others continually discovered over the past four years.
I’ve always tended to chose the breakout but what say you? Would you catch the tail of a comet like LKQ or get on what you hope might be a future rocket? And why?
March 15th, 2013
A oft-repeated refrain these days concerns the absence of significant inflation reported by the government. However, those who frequent supermarkets complain about increases in food prices. A recent page in the Financial Times included the following headlines; it’s enough to turn you into a survivalist, or “prepper”, begin building a bunker and store a food hoard (click on image to enlarge):
And what’s happening to the prices of companies in the food stuffs chain? Not surprisingly their moving higher (being swept along with the rest of the market?). We usually think of food stocks as safe havens to run to when the market gets shaky but, this time, there may be some strong fundamental drivers (along with major central bankers around the world flooding the market with their currencies) behind what could turn into dramatic food inflation and higher prices for the sector (click on symbols for charts; parenthesis are yield, volatility and relative strength):
Typically, these stocks have low volatility, offer dividend yields and, with reportedly a worldwide food shortage, may be perfect places to park some money as you sit out a market correction which could come during the “go away in May” seasonal market lull.
March 1st, 2013
CNBC never cease to amaze me the way they always trot out mostly bearish commentators on day’s when the market is declining severely, like Monday’s 1.83% plunge, but the bull’s when the market makes a stunning advance like the 1.27% rise a few days later. Rather than counter-balancing the market’s prevailing psychology, CNBC feels that it’s in their best interest to go with the flow: panic when everyone else is throwing stocks overboard and be euphoric when buyers are flocking back into stocks. Promote “risk off” on days when everyone has already decided to sell and “risk on” when the bulls are already stampeding.
They are a “news” organization and, as such, their time horizon is very short and they need to present stories and “talking heads” who primarily describe or explain why something is just happening or has recently happened. The information they offer is mostly anecdotal, opinions or canned offerings by companies rather than analytic and are, therefore, irrelevant to decision-making about the investable future.
That’s why I don’t watch the business media. Rather, I attempt to peer out into the future and see if I can perceive where the next turning point might be. Towards that end, I’ve been focusing an area I labelled the “Crunch Zone”, the range between the 2000 all-time high and the 2007 all-time high (approximately 1545-1575) and have been monitoring for Members since the beginning of February as the market closes in on that target:
- February 2: “The most glaring difference [between the 2007 attempt at crossing into new high territory and now] is that OBV [on-balance volume indicator] was also making new highs in 2007 but it has failed to do so, so far, this time. That difference could be attributed to greater investor skepticism in 2012 than there was in 2007 as evidenced by the huge volumes of cash still sitting on the sidelines and in fixed income/gold safe haven investments. That actually, could be positive indicator for the market actually finding success in breaking higher this time around.”
- February 10: “the 50-day moving average of daily volume of the 500 S&P stocks has declined since peaking in 2006. As the Index and OBV (on-balance-volume) continued to advance to new highs in 2007, average daily volume diverged and failed to move higher. As a matter of fact, average daily volumes have trended lower to where they are now about 50% of the that 2006 peak….What events will cause these trends to reverse direction?…Stocks usually move opposite of interest rates: when interest rates decline, stocks advance and when interest rates rise, stocks fall. Rates have been falling since 2009 and stocks have increase. But because of the Fed’s intervention, when interest rates begin to rise, stocks could also rise.”
- February 17: “Technically almost nothing new has happened other than the market has edged a little closer to the “crunch zone” ….The one significant development is on the volume side: 1) On-Balance Volume (OBV) has finally matched the peak during last year’s March high and 2) the 50-day moving average of daily volume seems to have finally bottomed out and shows a teeny-tiny upward slope…..Since the Market moves at glacier rather than human speed, we probably won’t get an answer of what follows the Crunch Zone interaction until the fall.”
- February 24: “the market is bumping up against the “Crunch Zone”….I wouldn’t be surprised if we were stuck in this area through the summer…..Don’t believe the media “talking heads” who offer explanations for a pause or correction at these levels grounded in the employment numbers, earnings reports, interest rates, exchange rates or corporate guidance announcements. The true explanation is that investors small and large have acrophobia, they fear heights, especially those at levels they’ve never seen before…..What encourages me is that there aren’t any bubbles today and, rather than being buoyant, the economy is still struggling to gain its footing. Rather than exuberance, there’s still a lot of skepticism and fear about the stock market and the economy, the sort of ground in which the seeds of a true bull market can begin to root and grow.”
We don’t need CNBC to tell us that approaching the bottom edge of the Crunch Zone will be a bumpy ride. As much as we might hang on every word of their prognostications, neither Cramer, Gartman, Kass nor any of the other familiar cast of characters can tell us whether we will ultimately cross through the Zone or bounce off it, reverse and begin sliding lower again (click on image to enlarge).
You’re familiar with the old saw that “timing is everything”; the next few weeks or maybe months is a perfect time to heed it. This is no time to make new commitments if you’re getting into the market for the first time or are looking to put some idle cash to work. You’ll know when this struggle between bulls and bears, supply and demand, in the “crunch zone” is resolved and you’ll have plenty of time to add new positions to participate in the next trend to higher levels. Don’t fret losing the first few percentage points; consider them insurance against the possibility that the market reverses instead.
On the other hand, I like most of the 70 positions in my Portfolio and don’t see weakness in most of their charts. There’s little reason to unload them and run the risk of losing out on the launch of the next wave higher if the “crunch zone” turns out to be only a milestone rather than an insurmountable wall.
I don’t know about you but I’m currently around 90% invested and have no plans to either unload in anticipation of a correction or bear market or aggressively put the remaining cash to work until this uncertainty is resolved. The Market moves at glacier rather than human speed so we probably won’t know what follows the Crunch Zone interaction until sometime around Fall. This may not be want you want to hear – we all like to see more action – but it’s unfortunately what we’re going to get.
February 22nd, 2013
The jarring correction over the past couple of days understandably sent shivers down my back. Should I start selling some of my winners in order to lock in those gains or just steel my nerves and hold on until this passes? I like most of my positions (currently over 70 stocks in the Model Portfolio) and the market is close to testing the strength of its momentum as it approaches what I have labeled the “Crunch Zone”, the area between the 2001 and 2007 all-time highs. Shouldn’t I do nothing and just wait? There is nothing in the technicals other than the fact of the approach to the all-time high to indicate that this is only another correction that the market has successfully weathered during the current bull market run since the 2009 bottom.
All of us are continually caught on the horns of this dilemma but even more so when the market is correcting: 1) hold on and run the risk of more significant losses or 2) sell and run the risk of unwinding some excellent positions. We usually evaluate our success as investors is to see whether our total returns (dividends and appreciation) are respectable. If we’re honest, we compare those returns against a benchmark [I use the S&P 500 Index] to see whether our efforts have produced returns in excess of what we would have earned in an Index Fund or ETF. What we don’t do often enough, however, is move beyond our current positions and analyze the previous trading that got us to where we are today.
- When did we sell stocks?
- How have the stocks that we did sell (often in panic in response to a market correction) perform after we had sold them?
- How did the portfolios of investors who bought our stocks from us perform after they took those stocks off our hands?
Since January 1, 2012, there were 87 sales transactions from the Model Portfolio. Some of those sales were swaps to move into other stocks and others were sales to reduce risk by moving into cash. I wanted to find out whether those sales were actually necessary? How did the sold stocks perform had I held on to them to the present? Did I sell winners or losers? Were the sales made as the market was rising or falling? What I can I learn from about my trading habits from those sales? For each transaction, I captured the gain/(loss) prior the sale, the gain/(loss) from the sale to current and the stock’s performance vs. the S&P 500 since the sale. Some of the results were surprising and revealing (click on image to enlarge):
Most interesting is that 65.5% of the sold stocks actually appreciated after the were sold. Luckily, most of the stocks sold continued to underperform since only 47% kept pace and 53% lagged the S&P 500 Index since their sale. Interestingly, the stocks with the largest gains after their sale were losers when I sold them. As a matter of fact, nearly 60% of the sold stocks that had losses prior to their sale have appreciated since. One of the largest post-sale gains was MTZ (click here for chart).
When were those stocks sold and should they have been? What was the market doing at the time of the sale? Except for one extremely short periods, the Market Momentum Meter has been Bullish Green since the end of January 2012 suggesting to Instant Alert Members that they have a fully invested posture (click on image to enlarge):
What stands out is that many of the sales occurred during months during and after the end of market corrections. For example, there were 19 sales in June and July after the Spring correction but only 9 in May and June when the correction was occurring; there were 11 sales during the Sept-Nov correction but 33 in the months after it had ended.
This may sound like overly personal but I think there are several lessons that anyone can take away from this exercise:
- It’s important to periodically review stock sales in addition to tracking stocks you currently own.
- Stick to a market timing discipline to avoid being unnecessarily scared out of the market when it is correcting.
- Continue to monitor stocks you’ve sold and buy them back rather than taking a risk on something untried if, after the correction ends, the stock continues its advance.
- Move into cash only when your market timing discipline indicates that the correction is likely to turn into a bear market reversal.
February 19th, 2013
The other day, Business Insider reprinted research originally written by Goldman Sachs on the topic of Behavioral Finance, a relatively new sort of financial science that investigates how biases often override the traditional, foundation principals of finance and influences our investment decisions. I last wrote about Behavior Finance while reviewing a favorite book, Far From Random, back on December 9, 2009. Goldman Sachs distilled the concept into a extremely easy to read and understandable schematic (click on image to enlarge):
Is there anyone who doesn’t recognize some or all of these biases in themselves or their investment decisions; if you don’t you aren’t being totally honest with yourself.:
- Mental accounts – unwillingness to invest in a good opportunity because you “missed out already”.
- Confirmation bias – cherry picking data to support a thesis, rather than objectively analyzing.
- Causal thinking – assuming a link between a news story and the share price performance that day.
How should you use this information?
- I would print out that schematic and past it prominently above your PC or workstation.
- Develop objective rules to guide your analysis and trading activity
The trading self-discipline is centered around the Market Momentum Meter to help guide my emotions when it comes to timing the market, my stock selection is based on breakouts across resistance in stock chart and my Sell Rules help me control against excessive churning and letting the winners to run (it’s spelled out in greater length in my book, Run with the Herd). You can never totally eliminate risk but you reduce the self-imposed risks brought on by volatile emotions, faulty reasoning and illogical behavior.
February 6th, 2013
Barry Ritholtz recently asked in his blog, “Is the Secular Bear Market Coming to an End?“. He goes on to say “Here we are, a few weeks away from the start of the 14th year of the secular Bear market that began March 2000. The question on more than a few peoples’ minds has been whether or not it is reaching its end.” Ritholtz goes on to give his definition of the term “secular bear market” and offers prerequisites required before the bear market can end. In short, he concludes
“Regardless of your answer to our broad question, there is one thing that I believe to be clear: We are much closer to the end of this secular cycle than to the beginning. Many optimists — most notably, famed technician Ralph Acampora — believe the secular bear market has ended. Even skeptics have to agree that we are more likely in the 7th or 8th inning than earlier stages of the game.”
and offers the following chart:
[Some of Ritholtz’s comments and image match those of found in Fidelity Investments Viewpoints of a few days earlier.]
Helping to prevent losing objectivity to my fundamentally optimistic nature has been a long-running discussion about how the exit from the Secular Bear Market that has hampered the market’s advance for the past 14 years might ultimately look like. The discussion began with a study of market behavior over the past 50-year that serve as the basis for the Market Momentum Meter, one of the principal topics of my book, “Run with the Herd“.
The data reveals that the market has fluctuated around a line that’s risen at a fairly consistent 7.5%/year rate since 1939. The upper and lower boundaries of fluctuations around that line are +/- 44% on either side of that upwardly sloping mean distribution line. The upper boundary was touched at the beginnings of the 1970 and 2000 decades, both of which were also the start of what turned out to be Secular Bear Markets. The lows of both those Secular Bear Markets were at the lower boundary of the range.
Having touched the lower boundary in 2009, I wondered whether the exit from the 1970’s secular bear market might serve as an analog to the exit from today’s secular bear market. “What the market trend be if it followed exactly the 1979-82 exit?” I’ve written about the exit here several times over the years, the most recent being last year on June 4 in “Revisiting 1970’s Secular Bear Market Exit … Again” [that post includes links to previous references to the Secular Bear exit going back to October, 2008.
It turns out that the current Bear Market and the one in the 1970s is that inflation and economic stagnation (then known as “stagflation”) had one major difference. Inflation had hit an annual rate of 13.5% when Jimmy Carter appointed Paul Volcker to head the Fed in August 1979. He immediately began attacking inflation by raising interest rates to unprecedented levels of 20% by June 1981; inflation soon began easing and interest rates began to fall.
The current Bear Market was diametrically opposed, especially since the Financial Crisis and bursting of the housing bubble, with the fear of deflation with the crash in housing and real estate values. To fight the “Great Recession” and ineffective or insufficient fiscal policies, Bernanke launched Quantitative Easing monetary policies which brought interest rates to low levels not seen since World War II. The following chart shows the different impact of the two monetary policy courses:
The 1970s Secular Bear Market exit analog may have been a good benchmark against which to measure the prospective current Bear Market exit. At this late date, I would have to conclude that not only have low interest rates helped the economy avoid a depression, they may have also helped the stock market exit more quickly from the Secular Bear Market. Rather than reversing and, thereby, extending the secular bear market’s life, so long as Bernanke keeps rates low, one can be confident that the market will soon exit the Secular Bear Market, cross into all-time new highs and, with luck, begin the first bull market advance since the 1990s.
January 31st, 2013
Everyone right now is trying to figure out how vulnerable the market is to a serious correction as it approaches its previous all-time highs. For example, CNN recently posted a piece entitled “Bull market winding down. Don’t panic” in which they overlaid onto the 2009-2012 S&P 500 the template of the market’s traditional psychological life cycle. [FYI, I’ve used that template myself in many earlier postings. For example, two years ago in Two Views of the Same Image, some had voiced fears that investors were “euphoric” and that meant that the market was approaching a peak followed by a significant downturn.]
In the recent CNN article, Laszlo Birinyi Associates suggested that the bull market “likely entered its final stage last summer. So far, the S&P 500 has climbed almost 8% during this period of ‘exuberance’.” Birinyi, says this stage of the market’s life cycle is when “fireworks” happen….. when all the people who have been reluctant and hesitant to invest in the stock market start realizing this isn’t the New York City subway system. There’s not going to be another train coming so they better get on board.”
The CNN article concludes that some of the best gains are to be had in the market’s final stages as everyone begins to pile onto stocks. This year, that run could be even more impressive as the fixed income bull market ends and investors sell those investments in favor of equities.
When I look at the S&P Index over the same period, I don’t see some rather arbitrary demarcations of changes in market psychology. I see another interesting pattern of market behavior (click on image to enlarge):
At the risk of being labelled an Elliottician, that is a practitioner of Fibonacci patterns and Elliott Wave Theory, I see that this bull market looks like a stair-step affair with each successive leg of the bull run lasting only 50-70% of the previous leg and the % change of each leg being only 50-80% of the immediately preceding one. The intervening steps down were less regular; excluding the 2011 correction that was amplified by the European debt crisis, each correction leg lasted approximately 60 calendar days and each (again, other than 2011) was 50-70% of the prior one.
Call it a stair-step or ever more tightly wound spring …. no matter what the analogy, the trend is unsustainable. In the next correction down leg down could be the last of the series. Each of the four previous corrections were between 50-70% of the immediately previous upleg. If it holds true again, a correction beginning soon could carry the market down to approximately 1410-1415, another pivot at the bottom boundary trendline.
Looking at the psychological terms in the Birinyi chart above, I can’t come to grips with calling today’s market psychology as “exuberant”. The reason the market saw an unusually large cash inflow in January was because they’ve been nearly non-existent since 2007. Even though we aren’t hearing much today about the inadequacy of job creation, consumer demand is still weak and businesses still hoard their cash fearing a weak economic future. Actually, the market rose 225% since March 2009 not because of a growing economy but only because of how far it had fallen from 2007 to March 2009.
Before there can be market “exuberance” there needs to be exuberance concerning the world economy, a condition that may be near but clearly hasn’t arrived yet. After the coming correction, psychology surrounding the economy might have improved sufficiently to allow the market to quickly maneuver around the tip of that coiled-spring and make a run at and finally, after 14 years, cross above the all-time highs.
January 17th, 2013
- In Debunking VIX Predictive Value of December 18, 2010, I compared the VIX on each of those 2,387 trading days (6/22/2001 and 12/18/2010) against the change in the S&P 500 Index over the following 30, 60, 90 and 180 days.
- The VIX has been below 20 nearly as many times as it was above; when VIX was below 20, the market has risen 53% of the time, regardless whether over 30, 60, 90 or 180 days.
- The VIX has been above 20 52.6% of the time and the market declined 61.7% of the time whether over 30, 60, 90 or 180 days.
- In Ignore The VIX As A Market Trend Indicator of March 17, 2010, I included a chart that had both the VIX and the S&P 500 Index and wrote:
“True, the VIX had an inverse relationship with the Index during 2008-09, but throughout the long 1986-2000 bull market, the VIX trend bore little connection with the Index having trended down and then up (indicated by the solid blue 300-day moving average) during most of the period…Falling VIX is interesting but I welcome it rather than finding it something to be fearful of.
- In Does VIX Inform or Mislead? of October 2, 2008, I reacted to everyone’s call that a VIX in the 40’s (then unusually high) indicated that a bottom was near. I wrote that “the VIX is a crude instrument and may be good at anticipating a short-term bounce but, until it hits extreme values (50 or more), it gives false indications that a bottom has been reached. Today, the VIX closed at a value of 45.26. I wouldn’t bet that we’ve touched bottom yet; a bounce perhaps, but not a bottom.” My Market Momentum Meter indicated that the market was still far from having bottomed and, actually, would actually decline another 39%over the next five months to the true bottom on March 9, 2009.
We’re again hearing that the VIX is at all-time lows leading to diverging conclusions. For example, a few days ago, the American Enterprise Institute in their blog wrote that “the VIX Index closed today at 13.45, the lowest level since May 2007, more than five years ago, and more than six months before the recession started in December 2007. Investor fear in the stock market has been consistently subsiding, and market volatility is now back to normal, pre-recession levels.”
On the flip side of the coin, there are those who are contrarian investors and believe that a low VIX indicates too much complacency whish in turn leads to a market top. For example, one blogger recently wrote “The VIX is the best measure of Fear in the market. Fear just hit 5 year lows and is about to hit its long-term lower trendline. Each prior lower trendline visit over the past few years predicted a fairly substantial market collapse in the ensuing weeks…..” And Fox Business News summed it up by this interview of Bespoke Investment co-founder Paul Hickey on the outlook for the markets.
Let me take another cut at getting to the truth about the VIX. In short, it is a lousy indicator of both near- and long-term market direction. This time I did a statistical analysis and discovered that there’s very little correlation between the level of the VIX on any given day and where the market will be 50, 100, 200 or 300 days later. I went back to April 6, 1998 and compared the value of the VIX on each day with where the market was at the latter date. The statistics, after over 3000 observations, were unconvincing. For those of you who are statistically oriented, the regression analyses produced the following results:
The most interesting finding in the data is how little the VIX contributes to explaining where the market will be 20, 50, 100, 200 or 300 days hence. The data say says, for example, that the VIX’s level on 3400+ trading days contributed only 0.14% to where the S&P 500 Index actually wound up 20 days later, a miniscule amount.
Interestingly, the contribution of the VIX increases to 5.12% in accounting for where the market ends up 300 trading days later, still a negligible amount.
Perhaps the accuracy of the VIX in predicting the market’s future direction is best transmitted in a picture (this one is really “worth a thousand words”);this one is shows the market’s percentage change 20-days after the VIX reading (click on image to enlarge):
As you can see that the S&P Index changes very little over the 20 days following the VIX reading regardless of whether the reading is below 20 or higher than 50. Furthermore, the market is just as likely to increase over the next 20 days as it is to decline…..again regardless of the actual level of the VIX, be it 15 or 65.
The major difference between the above chart for 20 days and those for longer spans between the VIX reading and the change in closing value of the S&P 500 Index is that the dispersion around the average change is wider. The longer the time that passes, the greater the opportunity for more dramatic market changes. To see those charts, click on 50 days, 100 days, 200 days, 300 days.
So if you hear or read a talking head warning of dire consequences too much complacency, of a VIX reading that is “too low by historical standards”, then remember this statistical analysis showing that the market is as likely to increase as it is decrease at nearly all levels of VIX readings …. that VIX and future market trends are virtually independent.