August 8th, 2013

Portfolio Management: Part 4 – “Preservation” or “Growth”? Why Not Have Both

Asset Allocations

 

The debate about portfolio management centers on whether one needs to “predict” or “react” for good performance.  The professionals settle that for themselves by claiming that since no one can predict the future, the best anyone can do is to diversify into many different asset classes (i.e., equities, fixed income, commodities, currencies, domestic and foreign, income and growth, large and small capitalization).  Economists like John Mauldin fall into this camp.  He and other perma-bear economists have been seeing top for most of the last 10-15% of the market’s move.  Mauldin recently wrote:

“This is a terrific time to take some profits and diversify away from the growth-oriented risk factors that dominate most investors’ portfolios. Instead of concentrating risk in one asset class or one country, investors can boost returns and achieve more balance by taking a global view, by broadening the mix of core asset classes, and by weighting those return streams to achieve balance across potential economic outcomes (rather than trying to predict the future) …..

 

broadening this mix of core assets – so that you have some element of your portfolio that responds positively to every potential economic season – and managing the relative allocations to each economic scenario may be your biggest opportunity to add value in the investing process.  You have a lot to gain from diversifying as broadly as possible, eliminating unrewarded costs, reducing your reliance on equity risk, and reining in the emotional mistakes that often lead investors to dramatically underperform.”

What these portfolio managers don’t understand is that one doesn’t necessarily have to predict where the market will be next week, next month or next year.  They claim that the only way to protect a portfolio against uncertainty when funds need to be withdrawn is to allocate assets among different classes based on today’s predictions and then rebalance periodically.  But an alternative approach is to aim for the highest returns while at the same time reacting and responding to abnormal and unexpected volatility immediately after it occurs.

In the previous article about the “Ultimate Buy-and-Hold Strategy” , the basic premise was that by assembling a specific mix of asset classes for a very long time (actually, 42 years) you would have reduced the volatility of a portfolio without significantly and not reduced its return.  However, nearly everyone would agree that, looking back with the benefit of hindsight, it would have been wonderful to have had the foresight to assemble a portfolio in 1970 and hold it until today, or 42 years.  But would that same approach produce the best results if you were to assemble the portfolio today, at the end of a 13-year secular Bear Market?  Thirteen years hence would we be better off if we assumed today that the next 13 years would be more similar to the 1982-2000 Bull Market than either the secular Bear Markets of the 1970′s and 2000′s?

We can’t predict the future but the odds are that the next 13 years won’t be even similar to the past 13 years.  Using the same data as Merriman’s, the “Buy-and-Hold” portfolio management approach delivers much different results had the portfolio started at different points and had different end dates?  As an alternative test, four hypothetical $200,000 portfolios were split into two parts, 60% in equities and 40% in fixed income, and rebalanced annually.  The annual returns since 1970 for equities and fixed income securities came from the St. Louis Federal Reserve Bank.  The four test portfolios were:

  • 1970-2012 (the 42 year “buy-and-hold” base case),
  • 1982-1999 (the last 17 year secular bull market),
  • 2000-2012 (the current 12-year secular bear market) and
  • 1970-1982 (the previous 12-year secular bear market).

There’s no question that, regardless of when the Portfolio was originally created, the 60/40 blended portfolio would always have been less volatile (as measured by the standard deviation of the portfolio’s annual change in value) than a 100% stock portfolio but more volatile than a 100% fixed income portfolio (click on images to enlarge).

Portfolio 1970-2012
Portfolio 1970-1982
Portfolio 2000-2012
Portfolio 1982-1999 But what is also true is that at end of the holding period, your portfolio would be worth more if you had been 100% in stocks than if you had blended in a percentage of fixed income …. sometimes much more.  As a matter of fact, if you had started your portfolio at the beginning of 1982 and held it somewhere close to the top of the Secular Bull Market when the Tech Bubble burst, then your portfolio would have delivered an average annual 19.12% and wound up worth 166% of the 60/40% mix and 388% of a fixed income only portfolio.  [Due to the spectacular decline in interest rates since the crash of the real estate bubble in 1977 - a trend that was as unprecedented as the secular bull market of the 1980-90's - a fixed income portfolio would have out-performed an equity portfolio by 152% but neither delivered much more than 7.2% average annual return for the 12 years.]

As I see it, you shouldn’t have to pick a single goal.  Are you wealthy enough to focus on “preservation” rather than “growth” in your portfolio?  Are you so preoccupied in other matters than you can’t react to changes in trend of any particular asset class; remember, both the Tech Bubble burst and the Financial Crisis evolved over 6 months.  Catch up on the major economic and business news once a week, make only incremental adjustments (i.e., not more than 10% of the portfolio at each decision) and you’ll be able to manage your portfolio.  You don’t need to predict the future you only need to review, react and respond as changes demand.  Portfolio management shouldn’t be day-trading but it can be more than just a “buy-and-hold” portfolio.  You can generate growth as well as preserve your capital.

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July 29th, 2013

Portfolio Management: Part 3 – Is Passive or Active Better?

Portfolio Management Action Reaction

In the previous article, I accused investment managers of encouraging their clients to “focus on the risks of losing principal rather than on opportunities for portfolio growth“.  I suggested that their aim was to match what you identified as future demands on your finances “with various funds they believe will minimize the risk of your not having the full amount when it was needed.”

This was reinforced to me when I came across an article in MarketWatch, entitled “The Ultimate Buy-and-Hold Strategy” by Paul Merriman in which the author states that his approach works “in portfolios big and small, doesn’t rely on predictions or require a guru or special knowledge of the markets or economy.”  He claims that his overriding goals are to build portfolios that deliver returns that exceed those available in “industry standard 60%stock/40% fixed income allocation” portfolios while subjecting investors to no additional risk as measured by the standard deviation of the Portfolio’s fluctuations.

To prove that his portfolio had returns greater than 8.5% and a standard deviation of no more than 11.6% (the long-term experience of a typical “industry standard portfolio”), Merriman assumed creating a hypothetical $100,000 in 1970 and allocating the funds into index funds and exchange-traded funds.  He concluded that over 40 years, “by far the biggest contributor to investment success (or lack of it) is your choice of asset classes.”  In other words, it’s not when you bought but what you you bought and that you not trade any of the individual securities during the period that improved results.

The conclusion sounded similar to notions I’ve heard over the years from the Efficient Market Theory crowd, the folks I wrote about extensively in my book, Run with the Herd.  According to the theory,

“Many investors think success lies in buying and selling at exactly the right times, in finding the right gurus or managers, the right stocks or mutual funds.  But being in the right place at the right time depends on luck, and luck can work against you just as much as for you.  Your choice of the right assets is far more important than when you buy or sell those assets.  And it’s much more important than finding the very ‘best’ stocks, bonds or mutual funds.”

Merriman takes a step-wise approach to assembling his “ultimate” portfolio by starting at the 60/40 mix and then adding higher return, lower volatility asset classes in relatively arbitrary proportions.  He then measures how much $100,000 would have grown to over 42 years, rebalancing the portfolio annually to keep the percentages fixed and what the volatility (how much the portfolio might have fluctuated over the period) might be.   The process results in the following model portfolio (right column is the end result):Buy and Hold Portfolio

The advice offered by most investment advisers is similar to  Merriman’s Ultimate-Buy-and-Hold Portfolio: assemble a portfolio of a diversified list of ETFs or mutual funds (which translates into hundreds or thousands of individual securities) and hold it for the long run (20 to 30 years).  It doesn’t matter when you by only that you hold the portfolio long enough for economic growth to make up any and all bear market draw downs (i.e., losses).   So the trickiest part of the Ultimate Buy-and-Hold Strategy is matching the right level of risk for each individual investor’s financial needs, in other words, the most important asset-class decision an investor makes is what percentage that investor should have in stocks and how much in bonds to his portfolio’s volatility to his future financial needs.

The final makeup of the Ultimate Buy-and-Hold Strategy is in the right-hand column and this hypothetical portfolio would have generated an average annualized return of 10.5% (compared with the 60/40% portfolio return of 8.0%) with a much lower volatility (11.7% vs. the standard portfolio of 17.0%) over 42 years.  However, at the end, Merriman discloses the caveats (my emphasis added):

“Every investment and every investment strategy involves risks, both short-term and long-term.  Investors can always lose money.  The Ultimate Buy-and-Hold Strategy is not suitable for every investment need.  It won’t necessarily do well every week, every month, every quarter or every year.  As investors learned the hard way in 2007 and 2008, there will be times when this strategy loses money….. this strategy requires investors to make a commitment.  If you are the kind of investor who dabbles in a strategy to check it out for a quarter or two, this strategy probably isn’t for you.  You may be disappointed, and you’ll be relying entirely on luck for such short-term results….. [the strategy] is not based on anything that happened last year or last quarter.  It’s not based on anything that is expected to happen next quarter or next year. It makes no attempt to identify what investments will be “hot” in the near future…. strategy is designed to produce very long-term results without requiring much maintenance once the pieces are in place.”

But here’s another catch!  According to Merriman, ” the best way to implement this strategy is to hire a professional money manager who has access to the institutional asset-class funds offered by Dimensional Fund Advisors (DFA).”  So is the study unbiased?  Is it self-serving?  Was there be any doubt as to what the study’s conclusions would say?

There’s wisdom in the saying “timing is everything” or it wouldn’t have survived for as long as it has?  You could still be trying to break even on a portfolio of large tech stocks like Cisco, Oracle, Microsoft, Ebay and Amazon had you bought them in 2000, at the peak of the Tech Bubble.  If you had bought your home in 2006 hoping that it would continue increasing in price and some day be your retirement nest egg then you’d have to put off retirement since it fetches a 10% lower price today.  You could have sold the gold coins inherited from a grandparent for $750/ounce in 2009 thinking the precious metal prices just couldn’t possibly continue increasing but recently discovered that it hit a peak of $1700 just two years later.  Or you might be that person who continues buying long-term government bonds today without questioning whether the secular bull market in fixed income securities be close to peaking; let’s ask them whether timing is important 3-5 years from now when his principal had declined 35% in value.

Timing does matter for individual securities, it matters when it comes to your portfolio and it matters for your financial well-being.  Portfolio management should be an active process not a passive one.  It’s a cop-out for investment advisers to tell you to predict your financial needs but not to try to predict the returns and future value of your investments.  There is an alternative.  There is a difference between predicting and reacting and it’s the same as the difference between gambling and managing your investments.  Market timing isn’t predicting the market’s future direction, it’s reacting to changes in the market’s trend as you see them taking place.  Strategies like the Ultimate Buy-and-Hold Portfolio doesn’t sound like management to me.  It sounds more like gambling that my portfolio isn’t depressed due to a bear market just when I need to unexpectedly withdraw funds or for planned needs.

The next article will focus on various types of risks and their relationship to portfolio management.

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March 1st, 2013

“Timing Is Everything”

imageCNBC 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).

SP 500-20130222

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.

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January 2nd, 2013

Shaking Off the Fear

If you’re an individual investor, one of the most important articles of last week besides the focus on the “Fiscal Cliff” debacle was an article in the December 29 Washington Post entitled “Bull market roars past many U.S. investors“.  The gist of the story was that “Americans have missed out on almost $200 billion of stock gains as they drained money from the market in the past four years, haunted by the financial crisis……Individuals are withdrawing money as political leaders struggle to avert budget cuts that threaten to throw the economy into a new slump.”

According to the Post, much of the damage to investors is “self-inflicted” because of fear and anxiety brought on by market volatility and memories of past “crashes”.  However, U.S. growth has improved and earnings tied to the economic are expanding.  Those improvements have been reflected in stock prices.  Of the 500 stocks comprising the S&P 500 Index, 481 are higher now than they were in March 2009 or when they entered the gauge.  Some of the statistics supporting these conclusions are:

  • Investors are lowering the proportion of stocks they own in retirement funds during a bull market for the first time in 20 years.
  • The proportion of stocks in the assets in 401(k) and IRA (excluding money market funds) fell to 72 percent from 72.5 percent in 2009.
  • The percentage of households owning stock mutual funds has dropped every year since 2008 to 46.4 percent in 2011, the second-lowest since 1997. [Of course, this could also result from the wide choice, availability and acceptance of competitive ETFs]
  • New money has gone to the relative safety of fixed-income investments as corporate bonds and Treasuries have received nearly $1 trillion since March 2009.

Housing is making a comeback and housing stocks were among the leaders last year, banks are on the mend and financial stocks were also among the best performers and 2013 auto sales are projected to approach 1.5 million. Is it time then for individual investors to begin fearing declines in the value of their fixed income investments as interest rates reverse (regardless of Bernanke’s protestations to the contrary) and start moving money back into stocks?

Meanwhile, institutional investors (the group I call the “herd”) hasn’t fared that well in the market either.  According to in December 26 Wall Street Journal article entitled “2012 Was Good for Stocks, Bad for Stock Pundits“,

  • At the end of 2011, Mr. Cramer warned investors to avoid bank stocks. Oops. They were one of the best-performing sectors in 2012. He urged investors to avoid real estate, but housing prices are up more than 2% from a year ago…..and the stocks of home builders, as measured by the S&P Homebuilders exchange-traded fund, are up 53.6%.
  • Of the 65 market “gurus” tracked during the last few years by CXO Advisory Group, the median accuracy for market calls is 47%. If that sounds low, or you wonder about the quality of the pundit, consider that the list includes such well-known names as Bill Fleckenstein (37%), Jeremy Grantham (48%), Bill Gross (46%) and Louis Navellier (60%).

So how do I deal with the noise coming from the “talking heads” and the uncertain produced by the market?  I maintain my equanimity in the face of volatility by relying on how market participants have behaved during similar situations in the market’s history.  I rely on my Market Momentum Meter to give me some indication of what market participants believe will happen, on average, in the near-term as reflected in their collective buying and selling decisions.  It’s measure by whether they are pushing prices up or down and the momentum behind those decisions.

The Market Momentum Meter turned a bright Green on January 31, 2012 when the Index was 1312.41, or 10.25% under today’s close of 1462.42.  It wasn’t Green for only 10 trading days during the year (the longest period was 7 days around the November correction low:

Like a parent who never quite trusts riding in a car that his kid is driving, I didn’t fully trust my own creation.  It took me a few months after that Green signal at the end of January to increase the money I had in stocks.  As hard as I tried to totally drown out the noise (news) about Euro debt and currency problems and, more recently, the fiscal cliff debates, I never could bring myself to be fully invested and, like corporate America, always had a significant amount of cash on the sidelines.  And then in after the November elections, as the Market reacted to the realization of a second Obama term and continued Congressional stalemate, it looked for a couple of weeks like we might see a repeat of the 2011 market implosion.  Fortunately, I waited this one out and saw money begin flowing back into stocks as prices quickly recovered.

Like many other market participants, I need additional “guarantees”.  Even though the Meter says that these sorts of market conditions in the past have lead to higher prices and that it’s all clear to be fully invested with relatively low risk, I still want to see the Index continue its assault on the all-time highs by first crossing above where it stalled out last September.  When that happens (which could be next week), I’ll feel more comfortable putting rest of cash to work.

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December 11th, 2012

Our Discipline: A Case Study in MED

As I’ve written here often, I believe the best approach for the typical individual investor is to manage their portfolios employing the following three steps: 1) a well-founded, unemotional approach to market timing, 2) the notion of industry group rotation and 3) diversification that spreads risk among a fairly large number of individual stocks (i.e., investing approximately equal amounts among stocks in the portfolio).

Put another way, the portfolio management effort down to answering the following questions: How much money should be put at risk in the stock market at any particular moment and, if new money is to be put to work, which stocks should be added to the portfolio? 

I solved the first question for myself several years ago.  I collected data back to 1963 on the daily S&P 500 Index and, by asking a series of “what-if” questions determined when it would have been better to have invested money in the market making an average return than having it sit idle on the sidelines.  Or, stated in the reverse, when would having money sit on the sidelines been better for long-term returns than had it been invested earning an average market return?  The analysis resulted in my Market Momentum Meter, an unemotional barometer of market sentiment, that allows me to shut my ears to all the media noise and hype about what they claim is “Breaking News” and focus instead on the truth about conditions conducive to momentum-driven markets over the past 50 years.  Following the Meter’s signals over the long run, investors could have avoided market crashes while still taking advantage of the bull market runs.  I can attest to the fact it helped me avoid the worst of the 2007-09 Financial Crisis Crash.

Once the Meter signals that it’s relatively “safe” to put new money to work in the market,  I use a two-step approach for finding the stocks best for carrying that risk.  I scan all stocks to find those that meet one of four different sets of criteria and, once having narrowed down the population of publicly-traded stocks, I look at their charts to find those that might have a good chance of crossing above levels that stymied their past advances (in other words, those that look like they could soon breakout across significant, long-term resistance trendlines). The first stocks to breakout are first in line as investment candidates.  The discipline requires me to sometimes be fairly active and at other times to do nothing but unemotionally watch the Portfolio run with the market or sit idle safely protected in cash.

The debate/negotiations in Washington has brought us again to a crucial market pivot point.  The Meter indicates that when market conditions look as they do today it might have been best for us to have money invested.  I have begun running those scans to begin finding those stocks that look like they’re ready to trigger Buy Points in their charts by crossing above key resistance levels.

While 75% of the stocks currently in the Portfolio show gains and 69% have outperformed the S&P 500 since their purchase, few have delivered the sort of results as has MED since its purchase last March.  I had never heard of Medifast when it dropped through one of the Scans and presented a compelling chart.  When I purchased the stock, I wrote in the Instant Alert to Members that the stock is “a product of yesterday’s Stocks-on-the-Move scan.  It has formed an inverted head-and-shoulders reversal pattern at what I hope will be the bottom of a multi-year descending wedge pattern.”  Since then, the stock has advanced 95%:

As the usual disclaimer says, “Past performance is no guarantee of future performance”.  But, I believe in the discipline and am using it today to find the next batch of stocks some of which, with some patience and luck, will hopefully deliver what turns out to be the outstanding performers over the next nine months or a year.

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November 7th, 2012

The Market and the Quadrennial Election Cycle

Nate Silver has really made a name for himself by accurately predicting the outcome of the past two Presidential Elections through statistical analysis techniques. I’m clearly not a statistician but several people did asked me, both before and since Tuesday, what I thought the elections would mean for the stock market. Which would be (have been) better for the market, a Romney or an Obama victory.  We don’t have to wonder any more because the market responded today with a 2.36% decline, the worst one-day drop in around six months.

Rather than guessing or predicting as to what the future might hold, I decide instead to look at the historical records, the precedents, to see what actually did happen in the years following each of the quadrennial elections since WWII.  It’s the approach I used in developing the market timing techniques underlying the Market Momentum Meter, a tool that has guided the amount of money I should pull out of the market to avoid the risks of a significant market downturn.  Without divulging proprietary information available exclusively to Instant Alerts Members, the Meter is on the verge of changing again from extremely bullish to significantly bearish.

Perhaps the following statistical analysis of the Market’s performance in the 12 months following the quadrennial elections will provide similar guidance:

  • Before yesterday, there were 16 quadrennial elections beginning in 1948
    • The market is not totally agnostic when it comes to political affiliation
      • Nine were won by the Republican candidate, seven by the Democrat
      • Of the 9 Republican wins, the market finished higher the following September 3 times and lower six times
      • Of the 7 Democrat wins, the market finished higher the following September 5 times and lower twice
    • The average changes in the market, as measured by the Dow Industrial Average, has been
      • an average 1.5% gain in the two months to year-end
      • a give back to break-even by the end of the following March
      • an average net gain of 2.0% by the end of the June following the Election
      • a marginal improvement to an average 2.3% by September, or 10 months after the election
  • There has been a wide range of changes during those time intervals:
    • in the 2 months to year-end, the maximum gain was 8.0% and the maximum decline -6.6%
    • in the period to March, the maximum gain was 13.2% and the maximum decline was -8.4%
    • to the following June, the maximum gain was 27.0% (during the Tech Bubble in 1997) and the maximum decline was -11.8% in 1948
    • to the following September, or 11 months, following the election the maximum gain was 31.5% in 2007 and the maximum loss was -19.4% in the Tech Bubble Crash of 2001.

Putting it all together, here’s a picture of the market’s action following each of the quadrennial elections. (click on image to enlarge)

Today’s -2.36% decline is at the outer limits of the total amount of decline that’s usually taking place between the Election and year end.  This one-day drop is more than 14 of the past 16 cycles; the only two that were greater took place in 1948 (-6.6%) and in 2008 when it declined -6.8% at the beginning of the Financial Crisis Crash.

Hopefully, today’s horrible reaction represents about half of the total we’ll see to the end of the year. Unfortunately, if the market isn’t able to recover this loss then there’s a strong possibility that there will be a follow through of the downside at the beginning of next year.

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October 31st, 2012

Lunar Cycles and the Market: An Annual Report

Hurricane Sandy was traumatic and something we haven’t really grasped the full implications of.  The people in its path suffered personal tragedies.  And in the midst of the news broadcasting on Tuesday was the almost overlooked fact that October 29 was a full moon.  Breaking through my focus on the scenes of devastation in lower Manhattan, Long Island, Connecticut and the Jersey shore was the thought that I had written several times over the past three years about the implications of the Lunar Cycle on stock prices.

For those unfamiliar with the theory, proponents believe that the market tends to be bearish when the move is waxing to its full phase and more bullish when it is in its waning phase to a new phase.  I’ve been tracking how accurate the theory might be in order to see whether there was any merit in using it to guide trading.  Coincidentally, The last I reported on the statistics happened to have been Nov. 7, 2011, almost exactly a year ago.  In that piece (if you click on the link you can see a table with the results for the twelve months ending 10/26/2011), I wrote:

“What has always intrigued me the most the cumulative changes during each of the two types of lunar phases. Since I started tracking these returns in 2009, if you had bought the SPY at the beginning of Waning Phase and sold at the end, your cumulative returns would have been 64.48%. I you had sold the SPY short at the beginning of each Waxing Phase and covered at the end, your cumulative returns would have been 27.99%. Combining the two would have nearly doubled your money in just over two years. Not bad for a theory that has yet to be statistically proven, wouldn’t you say?”

A year later, have the results changed much?

Nothing much except that strictly following the theory with a bimodal (on/off) investment in the S&P Index ETF would have produced a return of 12.88% for the prior twelve months and avoided a -1.26% loss for the waxing phases.  The theory has delivered the expected results accurately in 58% of the 24 phases (12 waxing and 12 waning).  The cumulative return for the waxing phases since July 2009 would haveincreased to 71.63% and the cumulative losses for the waning phases would have grown to -21.11%.

For reference, a buy-and-hold strategy for the period July 7, 2009 to last Friday’s close, the last trading day before the full moon would have produced a gain of 57.22%.

A friend scoffed at the theory claiming that the 60 phase results I presented to him was too small a sample.  I’ve added 24 more phases and will continue to add more until I convince him …. and me ….. as to its validity.

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October 23rd, 2012

Important Stock Market Supports

I must confess that I’m disappointed by both Romney’s lack of fire in his belly during last night’s debate and in the market’s negative reaction to that performance.  I’m one of the crowd who was looking for a bounce rather than a swoon as we moved on to the election and for several weeks after a Romney victory.  My market optimism was based on the belief that a Republican victory in both the White House and Congress would a big risk factor overhanging the market (whether fairly or not) as far as economic growth and would also reduce the risk associated with the country’s falling over the fiscal cliff at year end.

This morning’s reaction forces me to go reevaluate the game plan.  Perhaps the market will slip over the edge before the economy does.  But then again, there are many potential support levels to stop the fall …. albeit after some major damage to stock prices and portfolios (click on image to enlarge):

 

Those supports are indicated on the chart:

  • The lower boundary of an ascending channel that begin in late-2011.  Perhaps, not coincidentally, that trendline actually stretches back to the 2009 Financial Crisis Crash low (see chart below) and should, therefore, be considered an extremely important and strong one.
  • Three slow moving averages that all happen to currently be ascending
  • A horizontal trendline at approximately the prior 2012 low for the year

Unfortunately, however, my proprietary Market Momentum Meter will turn red suggesting that a move into cash is advisable based on similar situations in the past.  If the decline continues at the current rate, it will be similar to the rapid decline in 2011.  The recovery from that correction was fairly quick and dramatic so many investors, including me, were whipsawed and are still trying to recover.

Some look at the long-term chart a see the market back at the top of its 12-year secular bear market tradition range and, consequently, see the beginning of another major market crash (i.e., decline of 30-50%):

One usually bearish pundit recently wrote the following typical view of an impending market top,

“Cyclical bulls follow cyclical bears, so from those panic ashes a new cyclical bull was indeed born.  And coming from excessive lows, it would more than double the stock markets again.  Over the 3.5-year span running to just last month, the SPX blasted 116.7% higher!  And that brings us to where we are today, what is almost certainly the third major bull-market topping witnessed in this secular bear.”

Rather than the proximity to the top of the secular bear market range, my focus will be on that ascending trendline from the 2011 and 2009 lows, currently at around 1400.  A cross below that line would be a clear indication of more declines to come.

 

July 24th, 2012

How to remain unemotional in a volatile market

I look back at my last post and think, based on the market’s action over the past several days, what must I have been thinking?  How could I possibly gone so far out on a limb as to call for a market rise to 1575?  And how dispiriting is it when the market proceeds to decline by 1.6% over the next five trading days?  Well, I’ll tell you that it feels horrible.

In the same way that last Thursday we began to see some blue skies and some progress towards shoring up portfolios, today’s market is just as equally dejecting by pulling the rug out from under.  Fortunately, we have a ballast [anything that gives mental, moral, or political stability or steadiness] as market traders through the Market Momentum Meter.  This objective, unblinking, unemotional barometer of what has happened to the market in similar situations over the past sixty years steers our course and guides us through these turbulent emotional markets.

Last week, the market failed to touch the upper boundary of a channel giving the first hint of a potential problem.  For the rest of this week, the support provided by the zone demarcated by the two converging trendlines will have to hold or else we’ll have to rewrite the game plan.

For the time being, the Market Momentum Meter continues to ship a bright Bullish Green because the Index is above all its moving averages, only the 50-dma is out of sequence; however, only two of the moving averages are heading higher (200- and 300-dma’s) while two are heading lower (50- and 100-dma’s).  But the situation changes with each day’s trading activity.

Similar situation like this in the past became stabilized and trading confidence returned when the Index remained above the 50-dma so that it pulled the two laggard averages higher into a more proper alignment.  It’s not to say that the moving averages dictate the future.  What the statistics indicate is that investor confidence reflected in market prices is a progressively reinforcing loop.  The Index’s ability to advance will bring in more buyers waiting on the sidelines; price pressure will turn the remaining equity holders into sellers.

I have a long list of more than 100 stocks any of which I would have bought a week ago because of the strength of their chart actions.  The recent market action has put a definite questionable dent into their otherwise favorable prospects.

The past week has proven again that “50% of a stock’s price movement can be attributed to the overall market, 30% to its industry sector and only 20% to its own fundamentals.”  It doesn’t matter how strong the charts of stocks already in the portfolio or those in a watchlist look, they’re all trumped by the market’s action.  This is never more true than today since so many of the forces driving the market come from overseas.

June 22nd, 2012

An important, emerging new positive chart pattern in the S&P

Look at the chart inserted on the June 12 post below, “Cramer and One of My Five Lines in the Sand” and you’ll see the second trendline from the top at 1365.  When the market touched that level on Tuesday, I emailed Members the following yesterday morning:

“Yesterday, the market touched 1363 and then fell back. Let’s see what happens today after the Fed Meeting. We’re not alone in looking at this trigger level and, if there’s any positive signals out of Washington about more Fed easing then all those technicians could launch the next move higher. I, for one, will join the herd.”

Having set that hurdle saved us a lot of money because after hitting that level a couple of days ago, the market pulled back significantly.  If we had bought stocks on the expectation that the advance would continue, we would have been hurt terribly yesterday as near 90% of stocks declined as the market took its biggest hit in months.

Those who make decisions based on the news that the media decides to spotlight each day will continue to be whipsawed.  Yesterday, everyone was talking about double-barreled mauling of the market with Goldman Sachs’ bearish call and the across the board marking down of the major banks’ credit ratings by S&P.  Today, they’re talking about the market’s surprising resilience and how “the ratings agencies are always late”, “when they only reflect what everyone already knew” and “changing the rating on one company is important but adjust the whole industry changes nothing”.

But for those of us who take a longer-term view (like the chart in the June 12 post), we need as much of a downside confirmation before heading for the exits as we needed an upside confirmation.  The chart below identifies those two critical levels: 1360-65 for the bullish confirmation and 1260-1266 for the bearish confirmation.

Chart reading is a dynamic exercise as new data reveal new balances in the continually changing struggle between bulls and bears.  Interestingly, a new chart pattern has emerged as a result of the recent volatility: a flag sort of correction (descending parallel lines) coming off the March high.  Patterns like these are usually constructive as they underscore consolidation (or continuation) rather than reversal.  Furthermore, crossing above the upper boundary of this new pattern as well as the 1360-65 level only solidifies further the strength of the following upside move.