Category Archives: Discipline

February 1st, 2012

KISS in Market Timing Too

KISS is an acronym for the design principle articulated by Kelly Johnson, Keep it simple, Stupid!  Variations include “keep it short and simple”, “keep it simple sir”, “keep it simple or be stupid”, “keep it simple and straightforward” or “keep it simple and sincere.”  The KISS principle states that most systems work best if they are kept simple rather than made complex, therefore simplicity should be a key goal in design and unnecessary complexity should be avoided.

Other forms of this maxim are “everything should be made as simple as possible, but no simpler” (Albert Einstein), and “”Simplicity is the ultimate sophistication” (Leonardo da Vinci).  The principle is true whether applied to the design of an airplane, conceiving the theory of relativity or developing a market timing tool.

The following statement was made in a post today entitled “Golden Crosses Can Lead To Golden Losses“:

“While both CCM [that's Ciovacco Capital Management] market models have jumped back into bull market territory, the Bull Market Sustainability Index (BMSI) is approaching levels that are typically associated with market corrections.”

Stick a statement like that in front of me and I had to find out more about the BMSI to see how it compares with my MMM (Market Momentum Meter) which members know that it is serves as the barometer of my market timing approach and is previewed here.

About the only similarity between my MMM and the BMSI is that both are depicted on a scale that runs from Red to Green.  While my is a simple 5 traffic light approach, the BMSI looks like this:

But the similarity ends there.  Where the MMM uses 4 moving averages and the underlying S&P 500 Index, the BMSI is constructed with 30 different indexes as follows:

Complexity doesn’t mean precision and precision doesn’t mean accuracy.  It sort of reminds me of Cramer inferring in his “are you diversified?” segment that investors are safe and can generate high returns over the long run by merely diversifying their portfolio.  Aggregating a large and diverse number of indicators doesn’t necessarily give a better market timing signal than do a combination of four moving averages.

I’ve back-tested the MMM back to 1963 and am convinced that it performs well.  It got me out of the market in 2007, signaled reentry back into the market in 2009 and kept me safe through the fears brought on by last summer and winter’s worst European sovereign debt and US debt downgrades and budget debates.  It’s just issued a new signal indicating ….. sorry, that’s for members only.

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January 25th, 2012

“The Great Convergence”

In last week’s Recap Report recently sent to subscribers, I wrote and included the following chart:

“….. at the risk of being labelled melodramatic …. I see “The Great Convergence” coming to a head and finally getting resolved with the 18-month struggle between bulls and bears with (I hope it’s not just wishful thinking but an actuality) the bulls finally gaining the upper hand and finally being able to break into new higher ground.”

After today’s close and after closing higher for 20 of the last 23 trading days, the market is now up 10.01% since December 19.  Even more important is to note that today’s close was at 1326.06, almost exactly the level many chartists have touted as the breakout point that confirms an exit from this summer’s bear market and the continuation of last year’s bull market run off the lows.

It should also be noted that it’s almost exactly where the descending trendline connecting the 2007 and 2011 peaks is today.  However, rather than thinking in terms of points (e.g., 1325 or 1326) we need to think of a zone.  Every single trader doesn’t simultaneously decide to buy or sell which in turn causes a reversal at a single point.  Furthermore, the Index is composed of 500 different stocks in every economic sector and each of these stocks will have their own underlying market dynamics.  Market psychology does change when the market hits various levels but a change of psychology happens over time.

What the above chart indicates is a change in market psychology that’s been on-going since the bottom of the Financial Crisis Crash (see “Revisiting Housing and Banking With a New Ending” of a few days ago).  The ascending trendline since the bottom (higher lows) and the descending trendline from the pre-crash peak (lower highs) results in this “Great Convergence”.  The best momentum indicator (in my book) of moving averages across multiple time horizons are turning constructive adding to the conviction that a clear-cut signal to put, as they say in Wall Street, “risk back on”.

I believe there needs to be a 4-6% consolidation of this 10%, 23-day run and we’re going to look at it as a buying opportunity.  But if the market continues to zoom ahead another 2-3% without that correction, then it’s “damn the torpedoes, full speed ahead.”

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January 19th, 2012

Revisiting Housing and Banking With a New Ending

There was much conversation today about how the housing and banking industry was leading the market higher ….. which reminded me of a post I made close to a year ago on May 11, 2011 entitled “Homebuilders and Financials: The Economy’s and Market’s Missing Wheel“.  The S&P 500 closed at 1342.08 that day, 2.06% above today’s close of 1314.50.  I concluded that piece by saying

“If you believe that these two sectors will be able to successfully cross their resistance hurdles and begin advancing to levels last seen in 2008 then you should be “all-in” believing the market will continue heading towards the all-time high. If not, stay on the sidelines because rather than riding a car to the top it would be like riding a three-wheeler powered by the rest of the economy including: healthcare, retail, tech & internet, commodities, industrials and consumer non-durables.”

Because of the new more constructive view of housing and banking with the hopes of continued advances for stocks in those groups, I repeat that blog, including those charts, below:

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Two Industry Groups stand in the way of further market advances: financials and homebuilders.

Home building industry spokespeople go on CNBC regularly each time of the housing statistics are announced, like monthly sales, financing and refinancing, starts, or permits issued. And the spokespeople each time differentiate between the sales of new homes and resales, especially those that are in foreclosure or underwater; they also attempt to differentiate between national statistics which include negative information from extremely skewed markets like Las Vegas, Phoenix and Florida and the rest of the national housing market.

Discussed less frequently are conditions and prospects for banking, insurance, asset managers and the rest of the financial industry group. Since the bottom in 2009, I have believed the sector was a key to launching a true bull market:

  • On 3/20/09 in Financial Stocks are Laggards I wrote: “It’s often said that financial stocks are the Industry Group that leads the market out of the average Bear Market. In this case, however, the financials not only lead us into the Bear Market but they were the principal cause.
  • On 5/18/09 in XLF (Financial Sector ETF): What Now? I wrote: “XLF seems to be making what looks like the beginning of an inverse head-and-shoulder, a stock pattern that looks similar to the S&P 500 Index pattern….There’s only a one-in-four chance that XLF will be able to cross the resistance at the 13.00 neckline allowing it to move up to 17.00. It’s almost certain that 12-18 months from now XLF will be double what it is today [closed at 12.29 on that day], we just can’t say when.
  • On 6/7/2009 in XLF (Financial Sector ETF) = Market Health I wrote: “…the key to solidifying the market’s turn, to a true change in momentum from bear to bull is financial stocks starting to move up…..The financial sector is tied up with economic health, exchange value of the $US, interest rates and the health of the financial system itself. I’ll rest easier when I see the XLF successfully and with conviction cross above it’s neckline. “
  • On 9/16/10 in Housing and Finance: Two Superimposed Crises and Bear MarketsI wrote: “[The] graph clearly depicts what I see as two coincidental and superimposed Crises the country has faced. We often see them merged into one continuous stream of bad news but, in reality, there was a Financial Crisis (impacting business) that was preceded by Housing Bubble and Bust (impacting consumers).” and inserted the following graph, now updated to last night’s close (click on image to enlarge):

A year later, while the rest of the economy has regained its footing enabling the market to push higher (up nearly 20% since then), those two industry groups are still stuck below significant resistance and unable to breakthrough and push significantly higher:

  • Homebuilders
  • Financials

If you believe that these two sectors will be able to successfully cross their resistance hurdles and begin advancing to levels last seen in 2008 then you should be “all-in” believing the market will continue heading towards the all-time high. If not, stay on the sidelines because rather than riding a car to the top it would be like riding a three-wheeler powered by the rest of the economy including: healthcare, retail, tech & internet, commodities, industrials and consumer non-durables.

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If those groups start advancing this time, the rest of the market may not be much far behind.

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January 9th, 2012

Golden Crosses are Necessary but Insufficient

An event occurred last week that was pretty much under most investors’ radar screen; it was a Golden Cross in the DJ-30 Index.  If you don’t know what Golden and Black Crosses are, you should take a look at this excellent description from Bloomberg:


The moving averages of the S&P 500 Index haven’t yet formed that Gold Cross and won’t for another 15-20 trading days based on the recent rate at which the 50-dma is ascending.

Having said that, a Golden Cross is a necessary but insufficient market timing indicator.  As I wrote on November 23, 2010 in Listen to One Opinion or the Sound of the Thundering Herd, when some saw the signs that the market was approaching a reversal (John Murphy of StockCharts.com wrote “A decisive close below the 20-day line would signal a deeper correction that could take it down to its 50-day average, recently at 1,164.”):

“…the balance of technical evidence is now weighing more on the side of a breakout on the upside from the 12-month trading range than there is of a new bear market.

I’ve established a new near-term target of 1320 sometime before the beginning of the “sell-in-May” escape. The projection is based on what I perceive to be continually strengthening upside momentum as measured by my moving average-based Market Momentum Meter. While Murphy is looking at 20- and 50-day moving averages, I’m focusing on the fact that the 100-dma is a day or so away from crossing back above the 200-dma.

It may sound insignificant but when that fact is combined with the facts that 1) the 50-dma long ago crossed above the 200-dma (the Golden Cross) and above the 100-dma, 2) each of the three are above the 300-dma, 3) all four moving averages are trending up and, finally, 4) the index itself remains above them all then, historically, this tends to be very bullish. Especially since the market is at the early stage of that alignment.”

Five months later, on April 28, the market was 15.5% higher and closed at 1363, not far from my target set the previous November.

As my subscribers know, the Market Momentum Meter is at an extremely critical juncture in an excruciatingly narrow range just 0.11% away from issuing a Red/Bear and 1.40% away from issuing a Green/Bull signal.

This past October, in A Bull Market Signal? I discussed the Golden Cross and wrote

”

The problem with the indicator is that it over-prescribes an “all-cash” positions, periods when investors who follow the rule are out of the market when they should actually have been fully invested.

The problem can be remedied by combining the 200-dma rule with another common indicator and moving into an all-cash position only when both selling rules simultaneously proscribe an all-cash, risk-off posture. Only when the signal of one of the rules confirms the other should you actually assume the worst.”

Don’t be miss lead anymore by the media, miss read the market yourself and miss out on the next momentum-based trading opportunity.  Learn more by clicking here or the subscribe button below.

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November 10th, 2011

Caught in a Whirlpool

At times, the market these days makes you feel as you might when you’re caught in a whirlpool while kayaking down a raging river. You know the current’s general direction but all you sense at that moment is that you’re unable to extricate yourself from being whipped around in circles.

While “whirlpool” might describe how we investors feel, a better description of the market might be “unprecedented”. Frequent readers here know that my market timing discipline rests on the alignment of the S&P 500 Index and its 4 moving averages (50-, 100-, 200- and 300-dma). The alignment that indicates clearly that the market is in a bull trend is when the Index is above each of the moving averages and those averages trail the Index with them stacked from shortest to longest. Since 1963, that alignment has existed 34.5% of the trading days. As you might expect, the alignment that typifies a bear market is the mirror image with the Index below the four moving averages which are stacked from longest to shortest (300-, 200, 100- and 50-dma). That alignment has existed 9.2% of the days since 1963.

There are 120 possible combinations of the Index and its four moving averages in addition to the above two. Each combination has in the past nearly 50 years has been associated to so degree with a bullish or bearish market trend. Actually, 25 of the combinations have never existed because they would have required nearly impossibly extreme moves in either one of the moving averages or the Index itself. As of two weeks ago, one of those impossible moves actually did occur(click on image to enlarge).

For the first time in history (at least according to my records going back to 1963), the Index crossed above the four moving averages which were nearly in perfect bear market alignment. The crossing each time was so rare that it couldn’t be sustained for a day or two.

The problem is that the market jumped so far ahead of the prevailing consensus of market participants as reflected in the trend of its moving averages. There only one of three ways for the market to correct this imbalance:

  • Continue advancing far ahead of the moving averages and hope that the averages eventually catch up from this unprecedented situation
  • Stay generally at the current level until the moving averages catch up and return to a more common alignment
  • Decline to more quickly bring the alignment into balance and then turn up again in sync with the moving averages in a more typical reversal.

There’s are two out of 3 chance that the market can’t advance much further without the moving averages turning and heading higher. As my subscribers know, I remain skeptical and mostly on the sidelines.

November 4th, 2011

Reversion to the Mean – Ver. 3.0

Even though it feels frustration looking at a chart that stretches years, I find it worthwhile to periodically update the “Regression to the Mean” graph because it helps keep our expectations in check. Whether today we are bearish or bullish about prospects for the market’s near-term future, this “Regression to the Mean” will help moderate our views and help contain them within the realm of possibilities.

First, some background is necessary and warranted. I had accumulated monthly statistics on the S&P 500 Index going back to 1939 while working on my book, Run with the Herd, during the Financial Crisis Crash in 2007-08. What I had discovered was that when viewed within the broad sweep of history, the market had risen risen at a 7.5% rate, through bull market and bear, war and peace, economic boom and bust. In order to be able to make that statement, I added a boundary 44% on either side of that 7.5% average annual growth rate. Two, longer than 10-year secular bear markets during that 70 year history carried the Index from the upper boundary across the mean to the lower boundary.

After briefly crossing the upper boundary at the end of the Tech Bubble in 2000, the Index approached the bottom boundary in 2009 and lead me to conclude that the Financial Crisis Crash was approaching a bottom (click image to enlarge):

Today, the question to answer is what might be reasonably expected for the future? One model might be the exit from the previous 1969-1982 secular bear market. There are many similarities between that period and today: domestic economic, monetary and fiscal concerns, unpopular government leading possible change of administration. The major dissimilarity is the diametrically different interest rate environment.

If one superimposes the market’s track from the 1974 low on to an extrapolation from the 2009 low, one gets the following picture of what might be reasonably expected in the future:

The market started to face some headwinds and retreated as the country faced an election in 1980. It wasn’t until two years into the Reagan Administration that the market crossed above 1000 and began the long, 20-year bull market run.

As you can see, the market has been tracking fairly closely to the exit process back in the ’70′s so far. If that track continues for the near-term, we shouldn’t expect the market to approach the all-time high of 1365 until 2015 and not successfully cross above it until 2017. Let your hearts not lose hope because if it continues following the track then it could reach 3000 by 2020.

October 25th, 2011

A Bull Market Signal?

Mark Hulbert, in today’s Wall Street Journal’s Marketwatch blog asked the provocative question: “Did Monday’s strong market action satisfy one of the official definitions of a bull market?” His answer was “Believe it or not, the answer is yes — at least for some market indexes and some definitions. Which is remarkable, given that just three weeks ago another market index satisfied another of the official definitions of a bear market.”

The signal to which he referred was the Index crossing above the 200-dma. He writes further that “crossing the 200-day moving average is not the only definition that analysts use to determine a shift in the market’s major trend. Still, this trend-following indicator has a respectable record at anticipating shifts in the market’s major trend.”

In my market timing studies I’ve found that:

  1. market timing is a too imprecise practice to be binary (all-cash or all-in, bear or bull, yes or no) and
  2. a combination of indicators is more effective for market timing than any single indicator alone.

For example, in developing my Market Security Meter based on nearly 50 years of market data, I found that (as quoted from my upcoming book, Run with the Herd):

“….a neutral, unmanaged buy-and-hold strategy delivered $17,022, or a compounded average annual return of 6.20% over the test period between March 12, 1963 and December 31, 2009. Applying the 200-dma market timing rule to that same hypothetical portfolio over the 46-year period improved the results marginally and delivered an ending portfolio of $21,938, or 6.62% compounded average return before considering taxes, interest and transaction costs.

Selling when the Index crosses below the 200-dma is a simple rule that marginally improves total long-term results but it has disadvantages. For one thing, it works best in secular, or long-term, bull markets as contrasted with markets that have shorter-term (2-3 year) fluctuations like the period between 2000 and 2010. Over the 45 years in the database, the indicator suggested all-cash positions 33.4% of the all trading days….

The strategy produces a marginal improvement but not one that would have made you rich. You would have avoided some losses and wound up with a $4,748 higher ending balance. “

The problem with the indicator is that it over-prescribes an “all-cash” positions, periods when investors who follow the rule are out of the market when they should actually have been fully invested.

The problem can be remedied by combining the 200-dma rule with another common indicator and moving into an all-cash position only when both selling rules simultaneously proscribe an all-cash, risk-off posture. Only when the signal of one of the rules confirms the other should you actually assume the worst.

I combine the different configurations of these two indicators (plus some minor tweaking for instances that fall between them) into what I call a Market Security Meter:

The Index crossing above the 200-dma did actually change the color of the signal from Red but it surely didn’t cause the light to turn Green.

October 20th, 2011

A Scary Anologue Seldom Mentioned

According to Dictionary.com, an “analogue” is a noun meaning: something having analogy to something else.

Chartists are prone to mine historical data in search of precedents, patterns that closely resemble the current market believing that by projecting forward from those historical reference points they will come up with the performance that might be mimicked in the current future.

I think I’ve found an analogue that is amazingly close to the present, frighteningly so. Take a look at the following chart (click on image to enlarge):

I intentionally deleted any date references so that you’ll focus on the following:

  1. The market completed an imperfect head-and-shoulder reversal top; the right shoulder was small so the pattern could have easily been considered a double-top
  2. Moving Averages in perfect Bearish Alignment
  3. After crossing below the neckline, the market traded in a narrow, 3-4 month range
  4. However!
    1. the 50-dma reversed and
    2. the Index exited the range and crossed above all but 300-dma
  5. Volume peaked twice as the market declined to form the lower boundary of the channel after which volume appeared to evaporate

Now compare that to a chart of the market today:

The similarities are eerie and uncanny. I’ve notated the similarities on the above chart of today’s market.

Have you guessed what period the first chart covered? Unfortunately it was February 2007 to May 2008, a period that was the precursor of the recent Financial Crisis Crash. Just on the other side of the first chart above, the market crashed over 50% between May 2008 and March 2009!

In no way am I predicting that we’re on the doorstep of another crash. What I am suggesting is that you should take all the uplifting talk by Cramer and the other “talking heads” on the air and in print with a large dose of skepticism. The market may hinge on agreement in a European bailout financing plan and a continuation of favorable earnings reports here. Those point may be preconditions to assume that the market already hit a low for the year and the bull market can resume.

I think I’ll just wait, however, because if we had bought when we heard the same sort of talk as we entered our own bank and financial system emergency then we would have lost more than half and still had not recovered all our money. Rather than trust the professionals, I’m going to let the market tell me when it’s o.k. to put my money back to work.

October 15th, 2011

Consolidation or Reveral, That is the Question?

I’ve returned and am anxious to share my thoughts about the market. An incredible amount has happened since my last post on June 21, a brief three months ago that seems like a totally different era. The market then was also stuck in a trading range and we were wondering whether it would bounce off the range’s bottom boundary or crash through. I wrote then:

  1. Will it or won’t it break below the 200-dma and the neckline? I hope and now don’t believe it will. I think we’re going to see the market attempt to form a right shoulder of the emerging head-and-shoulder reversal pattern. If it does, that will be our opportunity to lighten up further at more favorable prices. And finally,
  2. Symmetry would bring the market back up to around 1340, 5-6% above current levels, over the next few weeks. At that point we’ll find out whether we’re out of the woods for the next leg up or reversing again and put the final nail into the head-and-shoulder formation.

In fact, there was another bounce with a high close of 1353.22 on July 7 followed by other close at 1345.02 on July 22. The bottom then fell out. In a mere 11 trading days, the market collapsed to close at 1119.46 or a 16.77% decline. Waffling around for the next two months with high volatility, the market skyrocketed over the past 9 trading days from a low of 1099.23 on October 3 to Friday’s close of 1224.58, or a 11.4% gain:

We were having dinner at a restaurant this evening and I couldn’t help but overhear the man at the next table was saying that he now feels like he really knows how to play the market. He was mostly in cash and was hoping for a further decline after which he’ll jump in with both feet and buy at the start of what he believed would be a new bull market.

The question to be answered is whether the recent trading range, as wide and volatile as it’s been, represents a reversal bottom or a consolidation? The market is now conveniently positioned at what would have been the target level of the previous head-and-shoulder reversal formed in February-July.

Does that technical explanation provide sufficient justification for considering the trading range a bottom? Is there sufficient positive macro-economic news for the bulls to generate sufficient upside momentum follow through to propel a move through the range’s top boundary and much higher? Or will the bears succumb to the negative background noise to enable the bears to take over and resume their push to lower levels. Here’s what I see unfolding:

I’m firmly in the camp of those who see the current trading range as a consolidation at the midpoint of a bear market that began this past May-July. If I’m correct, then we should see another 17-20% decline from current levels down to the 900-950 area. Two additional reasons that the 900-950 level will serve as this Bear Market’s bottom are:

  1. the neckline of the 2009 bear market inverted head-and-shoulder bottom that ended the Financial Crisis Crash should serve as strong support and
  2. that level continues the path followed when the market exited from the last secular bear market in 1980-82 (for more on that analog see December 3, 2009, July 13, 2010 and May 2, 2011)

There definitely are many fundamental reasons for staying bearish but the last nine days have been unusually convincing to those of the bullish persuasion. This last run-up has been especially hard on those who’ve remained bearish and elected not to jump on the bandwagon of those calling the recent run-up another “generational low” and a “chance of a lifetime” buying opportunity. My market timing indicator flashed a yellow warning light on August 2 but quickly switched to red on August 11 proscribing a move to “all-cash”.

I’ve been out of the market (and in a net short position via some ultra-short index ETFs) since then. However, taking a bearish stance vis-à-vis the market has been a terribly bumpy ride and, in all honesty, an unprofitable one since we got stuck in another trading range. My discipline was developed from an analysis of market behavior over the past 50 years; it alerted me to exit the market in January 2008 and spared me from the worst of the ensuing Financial Crisis Crash. I intend to follow it until it signals the reduction of risk and that it’s relative safe to return to the market.

May 12th, 2011

Sell Rule: Out-of-Favor Industry Groups

A mistake most traders, including myself, often make is focusing too much on what is or, more correctly, what will in the near future be moving higher. In the Weekly Recap Report I send to subscribers, I include both an breakdown by industry group of stocks in the current Portfolio as well as a list of Investors’ Business Daily’s top-ranked Industry groups and Groups moving up in rank the most during the past 3 months.

Our goal is finding tomorrow’s hot stocks. At the same time, however, we should make sure that the stocks we already have in our portfolios continue performing. It’s just as important to see what Industry Groups are falling the most in their rankings as it is those that are rising the fastest.

For example, I’ve been beating the drum for healthcare related Industry Groups for some months and, as of this past weekend, over 20% of the portfolio is now made up by stocks in those groups; most have performed extremely well. I included the following chart in a recent Recap Report of the Medical-Biomed/Biotech ranking showing that these stocks, as a group, have been among the best performers for over a year (click on images to enlarge):

What I hadn’t looked at or acted on was the other end of the spectrum – the industry groups that might have been falling fastest. If I had, I would have seen, for example, was that all the Oil & Gas related Industry Groups had begun losing their top rank positions. I had blinders on but if I had looked at the other end, I would have seen the stocks that were dropping the most in ranking. I would have seen groups like the Oil & Gas-International Exploration and Development:

and the Oil & Gas – Canadian Exploration and Development:

Both of these groups had started turning down from their top rankings in mid-March and were now among the lower half in ranking of the 197 Industry Groups; both were now clearly under the 20-week moving average of their ranking. If I had taken notice and acted as quickly to dispose of these stocks in the Portfolio as I was adding healthcare stocks then I would have preserved a lot of profit.

Last November, I wrote “My Sell Rules Discipline” in which one rule is selling “individual stocks where risks associated with that stock appear to have increased”; the fourth example is “an industry group if it falls out of favor”. I just didn’t follow my own rules. I have long known that Industry Group factors contribute about 30% to a stock’s movement (the market is 50% and factors related exclusively to the individual stock contribute the remaining 20%). What I just now re-learned, a lesson I won’t soon forget, is that we have to look not only for new stocks to add but also to find and quickly act to prune out stocks in Industry Groups out of which money clearly is flowing.