What’s Wrong With This Picture?

Friday, April 26th, 2013

by Bespoke Investment Group

The chart below compares the S&P 500 since the beginning of 2009 to the weekly bullish sentiment reading from the American Association of Individual Investors (AAII).  The two lowest readings in sentiment during this period came on 3/5/09 (18.92%) and 4/11/13 (19.31%).  If you look closely at the chart, the level of the S&P 500 during these two weeks couldn’t have been farther apart.  In early March 2009, the S&P 500 was trading at multi-year bear market lows, while on 4/11/13, the S&P 500 closed at an all-time high.  In other words, investors were as bearish at the depths of the financial crisis as they were when the market hit an all-time high, and that pretty much sums up the state of sentiment during this entire bull market.

Over the last two weeks, we have seen a modest rebound in bullish sentiment, which now stands at 28.29%.  However, even after the rebound, bullish sentiment is currently lower than it has been in more than 85% of all prior weeks during this bull market, and it’s well below the average of 37.8%.

Copyright © Bespoke Investment Group

Tags: Aaii, Bespoke, Investor Sentiment, Sentiment
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Looking Past Negativity to See Opportunity

Saturday, July 14th, 2012

July 13, 2012

Looking Past Negativity to See Opportunity

By Frank Holmes, CEO and Chief Investment Officer, U.S. Global Investors

This week, I spoke at FreedomFest in Las Vegas along with the world’s best and brightest minds, such as Steve Forbes, Senator Rand Paul, and Whole Foods CEO John Mackey. I discussed the growing global demand of resources and gold to a crowd of 2,000 (including the world famous Willie Nelson). Half of the group was attending for the first time, which demonstrates to me a growing curiosity to learn about macro trends shaping the world and affecting our investments.

Among investors these days, a fellow commodity bull is about as rare as finding a positive story in the media, especially when you look at the results of metals and natural resources during the first half of 2012. Only four commodities on our periodic table pulled off a positive return. Wheat grew the most, rising 13 percent, followed by single-digit rises from corn, gold and copper. On the negative side, coal lost more than 19 percent, followed by crude oil (-14.1 percent), nickel (-13.6 percent) and lead (-12.3 percent).

See the Decade of Commodity Returns on our Periodic Table

Fears of slowing global growth and how it will affect commodities have caused many investors to dig their heels in the ground and resist owning natural resources. Perpetuating this negative investor sentiment is the constant 24/7 news cycle punctuated with pessimism.

During a natural resources conference, Jeremy Grantham of GMO pounded the table for an investment in resources, but you wouldn’t know it by reading the headline of the CNN piece that covered the topic. In its article called, “Our planet will truly be toast,” CNN discussed Grantham’s comments on a global commodities shortage, saying he was “bearish on human resources…but bullish on natural resources investments.”

His argument focused on the swelling population in China, and the fact that the world has experienced a “great paradigm shift” around 2000, when commodity prices, which were negative for decades, “abruptly reversed course.” He told the crowd, “in the long run, you can’t afford to miss this opportunity.” We agree.

As you can see on McKinsey & Company’s chart above, the past decade shows a clear tipping point for resources. In 2000, I became the chief investment officer of U.S. Global Investors at a time when no one wanted to touch resources. We recognized the significance of China and Eastern Europe ushering in free markets, believing this to be a positive change, with emerging markets as big beneficiaries of this massive shift.

I like to use the metaphor of an ice cube to explain how new equilibriums can have significant effects. We all naturally understand what happens when you take ice out of the freezer. It changes form, from solid to liquid, but it’s still made up of hydrogen and oxygen.

A change in something the size of an ice cube does not have much impact—it’ll only leave a puddle of water on your counter. Instead, picture a glacier unthawing and how this huge chunk of ice drastically affects the world’s ocean level.

Or take H20 in steam form. At 211 degrees, water is way too hot to dip a finger, but it’s still one degree below the boiling point. As explained in the motivational book, 212: The Extra Degree, “Applying one extra degree of temperature to water means the difference between something that is simply very hot and something that generates enough force to power a machine.”

The significance of the changes in states of matter—whether it’s a chunk of melting ice or a steam engine—is that there is a tipping point that significantly alters the dynamics.

Tremendous population growth, changes in government policies, development of new technologies, urbanization trends work the same way. It’s what Grantham called “the great paradigm shift” and they have equally dramatic effects on how we invest in commodities, change opportunities and adjust for risk.

Smart investors look past the rampant negativity in the media to see these patterns and anomalies to determine where the opportunities and threats lie. Americans can see how shale gas technology has changed the dynamics of oil and natural gas. The chart from the U.S. Energy Information Administration’s Annual Energy Outlook 2012 shows how consumption of petroleum and other liquids in the U.S. have significantly changed while production has been rising. Consumption rose throughout the 1980s until about 2005, when it dropped off. Meanwhile domestic production was declining. Between 2005 and 2010, a significant change happened: consumption dropped, then leveled off and the rate of production shifted higher. The EIA estimates that because of these shifts, net imports will decrease to 36 percent in 2035 from about 49 percent today.

As Brian Hicks, a portfolio manager of the Global Resources Fund (PSPFX) pointed out in a Smart Money article, when oil prices rise, people put more resources into getting the commodity out of the ground. He says, before the oil-price boom, these reserves would have been unprofitable, “now they’re anchoring ‘a gold rush.’”

Similar to higher production in the U.S., Iraq production is on the rise, Libya supply is climbing and demand remains tepid. Morgan Stanley Commodity Research believes that the “path of least resistance for oil is down.” The firm estimates OPEC spare capacity at the end of 2011 and 2012 to be around 4 million barrels per day with a global consumption level estimated at 89 million barrels each day. This compares to today’s spare capacity of around 2 million barrels each day. “If OPEC production continues at today’s levels, stocks would build above normal through 3Q and supply would outstrip demand in 2012,” says Morgan Stanley.

This is why diversification among natural resources is vital. Because there’s always an ebb and flow of commodities, both seasonal and cyclical, it’s important to anticipate these global trends to know how to participate.

The key is to adapt to external elements like the way oil production adapts to excess supply. Usually the easy answer, such as staying on the sidelines, isn’t the best answer, though. Take a look at today’s yield on a 10-year Treasury—it’s 1.49 percent. Meanwhile, inflation is at 1.7 percent. This means that after you factor in what you’ve lost from the destructive force of inflation, you’re left with a negative return.

Instead of being stuck with this potentially losing proposition, we believe there are plenty of opportunities out there. Last week, I discussed dividend-paying resources stocks: Of the companies in the S&P 500 Index, materials pay an average yield of 2.3 percent, utilities pay an annual rate of 4.1 percent, and energy stocks pay a dividend yield of 2.2 percent.

And if you need to park some money for a few years, you may have noticed that 3-year certificate of deposits offered at a bank are yielding about 1.34 to 1.42 percent. These CDs lock up your cash for three years and generally come with a penalty for early withdrawal.

There may be better yielding alternatives out there for those that can take on some risk as they seek higher returns. For example, U.S. Global Investors’ Near-Term Tax Free Fund (NEARX) had a higher 30-day SEC yield on a tax-equivalent basis based on a 35 percent tax rate as of June 30, 2012. Also, the fund invests in bonds that have an average maturity of just over 3 years, which is about the same holding period as a 3-year CD.

While the fund is not FDIC insured, it does provide the flexibility of daily liquidity that comes with a mutual fund.

Could this four-star fund work for your portfolio? To find out, you can talk to one of our Shareholder Services team members Monday through Friday from 7:30 a.m. to 7 p.m. (CST) at 1-800-873-8637 or click here to send us an information request.

I’ve rarely been more excited to talk positively about how investors can take advantage of the anomalies and trends in the market. In a few weeks, I’ll be presenting these ideas at the Agora Financial Investment Symposium in Vancouver. Hope to see you there!

Tags: Ceo John Mackey, Chief Investment Officer, Cnn, Frank Holmes, Freedomfest, Global Commodities, Global Demand, Investor Sentiment, Jeremy Grantham, John Mackey, Lead 12, Macro Trends, Natural Resources Conference, Population In China, Senator Rand, Steve Forbes, U S Global Investors, Whole Foods, Whole Foods Ceo, Whole Foods Ceo John Mackey
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Technical Take: In a Pickle

Tuesday, July 10th, 2012

by Guy Lerner, The Technical Take

Last week’s comments will certainly  suffice to explain how sentiment is impacting the current price action, so here they are: “From a sentiment perspective, the data remains consistent with a market top rather than the next launching pad to a new bull market or even a sustainable bull run. For several weeks, I have been of the opinion that whatever bounce develops would not carry too far because sentiment really wasn’t too bearish at the bottom. Large rallies usually start with real extremes in investor sentiment and consensus among the sentiment data, which we did not see despite the SP500 dropping about 10% over 8 weeks from the April highs. Although the “dumb money” was bearish (i.e., bull signal), corporate insiders were neutral. Throw in the fact that investors have been primed to front run anything that sounds like quantitative easing or bail out, you can understand why investors weren’t too concern. Don’t worry some central banker has your back.”

What I find fascinating is that investors know what is exactly driving this market.  It is bailouts,  quantitative easing, asset purchases or whatever you want to call it.  These plans can be real or just come from the mouths (i.e., jawboning) of central bankers.  I was listening to CNBC earlier in the week, and the disappointment of the hosts over the market’s response to the European Central Bank’s rate cut was palpable.  With the pre-market futures down about 0.5%, they immediately understood that some entity (i.e., Federal Reserve) would need to step in and do more.  Mind you this is pre-market action, and the SP500 is still only a couple of percent below the recent cyclical highs!  No reason to hope for a good jobs report or better earnings.  Maybe that is asking for too much.  Or maybe investors understand that positive data points takes more QE off the table.

The promises to fix the economies (i.e., equity markets) of the world with more debt are coming almost daily now.  The market’s response to each of these “fixes” seems to be getting less and less.  In addition, whether QE is the right policy still remains in doubt.  After all, it hasn’t turned the US economy around yet and some would argue, asset purchases and debt creation have put the US economy on a weaker foundation.  It would seem that investors are in a pickle.  More of the same is not working, and it just may require lower equity prices for investors to get what they really wish for.

The “Dumb Money” indicator (see figure 1) looks for extremes in the data from 4 different groups of investors who historically have been wrong on the market: 1) Investors Intelligence; 2) MarketVane; 3) American Association of Individual Investors; and 4) the put call ratio. This indicator is neutral.

Figure 1. “Dumb Money”/ weekly

Figure 2 is a weekly chart of the SP500 with the InsiderScore “entire market” value in the lower panel. From the InsiderScore weekly report: “Insider trading volume began a seasonal decline last week. Companies generally close trading windows for insiders 10-14 days prior to quarter’s end and reopen them following their subsequent earnings announcement. Volume will continue to dissipate over the next few weeks and getting a macro read will be difficult because of the limited number of insiders who are free to trade.”

Figure 2. InsiderScore “Entire Market” value/ weekly

Figure 3 is a weekly chart of the SP500. The indicator in the lower panel measures all the assets in the Rydex bullish oriented equity funds divided by the sum of assets in the bullish oriented equity funds plus the assets in the bearish oriented equity funds. When the indicator is green, the value is low and there is fear in the market; this is where market bottoms are forged. When the indicator is red, there is complacency in the market. There are too many bulls and this is when market advances stall. Currently, the value of the indicator is 63.72%. Values less than 50% are associated with market bottoms. Values greater than 58% are associated with market tops. It should be noted that the market topped out in 2011 with this indicator between 70% and 71%.

Figure 3. Rydex Total Bull v. Total Bear/ weekly

Tags: Asset Purchases, Cnbc, Corporate Insiders, Cyclical Highs, Disappointment, Dumb Money, Extremes, Federal Reserve, Guy Lerner, Investor Sentiment, Launching Pad, Market Futures, Mouths, Pickle, Pre Market, Qe, Quantitative Easing, Rallies, S&P500, Sentiment Data
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The Odds Are Against You

Monday, July 9th, 2012

by Guy Lerner, The Technical Take

I define the price cycle as the path prices take from low to high and back to low again.  To help determine where I am in that cycle I use investor sentiment.  Typically, extremes in bearish sentiment often define cycle low points leading to bullish gains, and extremes in bullish sentiment often define cycle high points leading to a loss of price momentum at best and more commonly, a retracement in price of the price move from low to high.  This is the price cycle — “wash, rinse, repeat”.

The most recent bullish price cycle hit a low on October 7, 2011 and it did not peak out until April 20, 2012.  Since April 20, 2012, the market (i.e., SP500) has sold off a little bit and has bounced little bit, but prices are still below the sell point.  We are at that point in the price cycle where the bullish gains have been made and price momentum has been lost.  We have yet to hit an extreme in bearish sentiment that would define a low point in the price cycle, and as I have stated for months now , the only way we can get there is to have lower prices.   To understand what I am talking about, I will quantify these price dynamics.

So let’s create a study that looks at the part of the price cycle where upward price momentum has already slowed and prices have yet to hit a low point.  In essence, what I am doing is looking at the part of the price cycle when prices are above the 200 day moving average and momentum has fallen out of the trend.  For the study then, our buy signal occurs when the upward price thrust of the price cycle has ended and prices are above the 40 week moving average.  Our sell signal is either new extremes in bearish sentiment (i.e., the bottom of the price cycle) or prices have closed below the 40 week moving average.  What I want to know is what happens to price in the period  after momentum of the upward thrust of the price cycles wanes to the next buy signal.  This would replicate the current conditions in the market.  The study is based upon the SP500 data starting in 1991.

Figure 1 shows the equity curve for this strategy, and it is not pretty.  So once momentum of the initial price thrust is over, buying the market just because price is above its 40 week moving average is a poor idea.

Figure 1. Equity Curve

Figure 2 shows the maximum adverse excursion (MAE) graph.  The MAE graph shows every trade from a particular strategy, and it is a measure of how much a trade moves adverse to its entry position.  MAE is a measure of investor angst.  For example, take the one trade inside the blue box.  This trade had an MAE or draw down of 6% before being closed out for a 1% loss.  We know it was a losing trade because the caret is red.  Now look at the 13 red carets to the right of the orange line.  This tells us that 13 out 38 total trades had an MAE greater 5%.  In other words, if you buy at the top or when everyone else is bullish or when the upward initial price thrust has diminished, it is likely that you will experience an excessive draw down.

Figure 2. MAE Graph

There are several take away points here.  Buying just because prices are above the 200 day moving average is a bad play.  Momentum needs to be present.  One way to have momentum develop is to have investors out of the market wanting in; these are the investors on the sidelines willing to pay up for prices. The best way to put investors on the sidelines is to have lower prices.  Unfortunately, the problem with the current market is that it has not done a good job of putting investors on the sidelines as the persistent belief in the “Bernanke put” has put a floor under this market.  Unfortunately, this dynamic is also responsible for the current listless price action.  Furthermore, buying the market when prices are well above the 200 day moving average, which is usually when the pundits and TV analysts are signalling the all clear, is probably a poor idea most of the time.

From this perspective, the data from this study is consistent with the notion that we are in a range bound market at best or in a process where we need to see lower prices before heading meaningfully higher.  The odds of success would be in your favor if you are buyer when others are bearish.

Tags: Bearish Sentiment, Bullish Sentiment, Curren, Extremes, Guy Lerner, Investor Sentiment, Little Bit, Moving Average, Odds, Path, Price Cycle, Price Cycles, Price Dynamics, Price Momentum, Price Move, Retracement, Trend, Upward Thrust, Wash Rinse
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Investor Sentiment: Don’t Worry Some Central Banker Has Your Back

Wednesday, July 4th, 2012

by Guy Lerner, The Technical Take

Last week, I complimented investors for understanding what is driving this market.  It is the perception that some central bank has back stopped asset prices.  And on the heels of another announcement by policy makers to bail out and backstop the banks and governments in Europe, the markets rallied strongly.  Like I said, investors know what to do once they understand what to do.  But beyond Friday’s euphoria (relief?), I am not so sure I can attach any long term significance to a plan that is long on hope and short on details.  Nothing has changed including investors’ perceptions as policy makers acted like they were suppose to.  And the markets reacted like they were suppose to.  Yet it is not clear to me why this latest proclamation is the “one” that will fix everything.   The big question does Friday’s action have any meaning for the markets beyond the short term.

From a sentiment perspective, the data remains consistent with a market top rather than the next launching pad to a new bull market or even a sustainable bull run.  For several weeks, I have been of the opinion that whatever bounce develops would not carry too far because sentiment really wasn’t too bearish at the bottom. Large rallies usually start with real extremes in investor sentiment and consensus among the sentiment data, which we did not see despite the SP500 dropping about 10% over 8 weeks from the April highs. Although the “dumb money” was bearish (i.e., bull signal), corporate insiders were neutral. Throw in the fact that investors have been primed to front run anything that sounds like quantitative easing or bail out, you can understand why investors weren’t too concern.  Don’t worry some central banker has your back.

From this perspective, little has changed to alter the “call”: this is a market top.  The price action and sentiment picture remain consistent with this observation.  Friday’s “pop” in the market could just as easily be due to calendar effects rather than another proclamation to fix an unfixable problem.  I don’t think there is any great significance to Europe’s latest plan to fix the world as we knew it!

The “Dumb Money” indicator (see figure 1) looks for extremes in the data from 4 different groups of investors who historically have been wrong on the market: 1) Investors Intelligence; 2) MarketVane; 3) American Association of Individual Investors; and 4) the put call ratio. This indicator is neutral.

Figure 1. “Dumb Money”/ weekly

Figure 2 is a weekly chart of the SP500 with the InsiderScore “entire market” value in the lower panel. From the InsiderScore weekly report: “Insider trading volume began a seasonal decline last week with the number of unique buyers and sellers falling more than -40% sequentially. Companies generally close trading windows for insiders 10-14 days prior to quarter’s end and reopen them following their subsequent earnings announcement. Volume will continue to dissipate over the next few weeks and getting a macro read will be difficult because of the limited number of insiders who are free to trade.”

Figure 2. InsiderScore “Entire Market” value/ weekly

Figure 3 is a weekly chart of the SP500. The indicator in the lower panel measures all the assets in the Rydex bullish oriented equity funds divided by the sum of assets in the bullish oriented equity funds plus the assets in the bearish oriented equity funds. When the indicator is green, the value is low and there is fear in the market; this is where market bottoms are forged. When the indicator is red, there is complacency in the market. There are too many bulls and this is when market advances stall. Currently, the value of the indicator is 61.77%. Values less than 50% are associated with market bottoms. Values greater than 58% are associated with market tops. It should be noted that the market topped out in 2011 with this indicator between 70% and 71%.

Figure 3. Rydex Total Bull v. Total Bear/ weekly

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Tags: Asset Prices, Backstop, Bounce, Consensus, Corporate Insiders, Dumb Money, Euphoria, Extremes, Governments, Guy Lerner, Investor Sentiment, Launching Pad, Nbsp, Obs, Perception, Perceptions, Quantitative Easing, Rallies, S&P500, Sentiment Data
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Investor Sentiment: Bull Signal Awaits

Sunday, June 10th, 2012

by Guy Lerner, The Technical Take

The “dumb money” indicator is now showing that investors are extremely bearish, and this is a bull signal. On average, the best time to buy is 1 week after the signal. Several caveats are worth noting.

First, about 80% of the signals will produce positive results within a reasonable draw down. What is meant by “reasonable”? The SP500 should bottom within 6% of next week’s buy point. If the SP500 drops below next week’s buy signal by more than 6%, then this is a failed signal. A failed signal is the market’s way of saying that what we expect to happen has not happened, and failed signals can lead to very strong moves opposite to those expectations.

Second, the current extreme reading in the “dumb money” indicator is not supported by other measures of investor sentiment. For example, the Rydex market timers are still showing extremes in bullishness and in some sense, they have been unwinding their bullish positions over the past several months. By no means are they bearish, and this data series is looking more like a market top than a market bottom. Corporate insiders did hit extremes in buying 2 weeks ago, but like the current “dumb money” indicator reading, these were only “mild” extremes. So what does it mean? The resulting snap back rally is likely to be weak and unlikely to carry as far as a rally that begins when all of our measures of investor sentiment are showing much greater extremes of bearishness.

The market has bottomed where one would expect it to have bottomed — near its 200 day moving average. I am sure this has brought a sense of order and relief to the bulls and to those investors who were buying the kool-aid only 2 short months ago. Ahh, this is how bull markets function. Now that this temporary blip (mis-pricing) is over, we can get back to the business of being bullish. I am not trying to discount the current bull signal. A bottom is being forged. It would be nicer to have seen greater extremes in bearish sentiment at the bottom as this leads to stronger future returns. I could just as easily make the case that this is the last gasp of an aging bull market.

The “Dumb Money” indicator (see figure 1) looks for extremes in the data from 4 different groups of investors who historically have been wrong on the market: 1) Investors Intelligence; 2) MarketVane; 3) American Association of Individual Investors; and 4) the put call ratio. This indicator is showing extreme bearishness.

Figure 1. “Dumb Money”/ weekly

Figure 2 is a weekly chart of the SP500 with the InsiderScore “entire market” value in the lower panel. From the InsiderScore weekly report: “S&P 500: Sentiment Remains Positive But Volume Declines…. Russell 2000: Number of Buyers Drops But Sentiment Remains Positive. ”

Figure 2. InsiderScore “Entire Market” value/ weekly

Figure 3 is a weekly chart of the SP500. The indicator in the lower panel measures all the assets in the Rydex bullish oriented equity funds divided by the sum of assets in the bullish oriented equity funds plus the assets in the bearish oriented equity funds. When the indicator is green, the value is low and there is fear in the market; this is where market bottoms are forged. When the indicator is red, there is complacency in the market. There are too many bulls and this is when market advances stall. Currently, the value of the indicator is 62.78%. Values less than 50% are associated with market bottoms. Values greater than 58% are associated with market tops. It should be noted that the market topped out in 2011 with this indicator between 70% and 71%.

Figure 3. Rydex Total Bull v. Total Bear/ weekly

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Tags: Bearish Sentiment, Best Time, Blip, Bull Markets, Bulls, Caveats, Corporate Insiders, Dumb Money, Extremes, Guy Lerner, Investor Sentiment, Investors, Kool Aid, Market Bottom, Market Timers, Measures, Moving Average, Rally, S&P500, Signals, Snap Back
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Investor Sentiment: Mixed, Nowhere, and Without an Edge

Monday, May 28th, 2012

by Guy Lerner, The Technical Take

Equity investor sentiment remains mixed.  The Rydex market timers (i.e., dumb money) remain excessively bullish, and this is a bear signal.  On the other hand, company insiders (i.e., smart money) are becoming more bullish, but the value is not yet extreme, which would be a bull signal.  The “dumb money” indicator is neutral.  I have been of the opinion that this is a market top.  If prices were to move higher from this juncture, selling would likely ensue once the market became over bought.  A better, more durable bottom leading to a sustainable price would more likely be seen if investor sentiment became more bearish.  And what is the best way to bring out the bears?  Why of course, lower prices and breaks of support levels and widely followed moving averages.  With investor sentiment essentially mixed we are nowhere and without an edge.  Lower prices would be great.  Higher prices will only delay the inevitable.

The “Dumb Money” indicator (see figure 1) looks for extremes in the data from 4 different groups of investors who historically have been wrong on the market: 1) Investors Intelligence; 2) MarketVane; 3) American Association of Individual Investors; and 4) the put call ratio. This indicator is  neutral.

Figure 1. “Dumb Money”/ weekly

Figure 2 is a weekly chart of the SP500 with the InsiderScore “entire market” value in the lower panel. From the InsiderScore weekly report: “A market-wide Industry Buy Inflection was triggered on May 18th, the first since August 9, 2011. Buy Inflections are our strongest quantitative indicator of positive macro sentiment are triggered when buying reaches extreme levels. Presently, insider buying levels (as measured by the number of insiders buying, the number of companies with insider buying, the dollar value of purchases, etc.) is higher than normal, however, insider selling levels are normal. Typically we see insider selling levels fell to well below normal when there’s higher than normal insider buying levels. Buying is widespread, led by small- and mid-caps, though the big caps began showing a stronger buy signal as the week went on. “

Figure 2. InsiderScore “Entire Market” value/ weekly

Figure 3 is a weekly chart of the SP500. The indicator in the lower panel measures all the assets in the Rydex bullish oriented equity funds divided by the sum of assets in the bullish oriented equity funds plus the assets in the bearish oriented equity funds. When the indicator is green, the value is low and there is fear in the market; this is where market bottoms are forged. When the indicator is red, there is complacency in the market. There are too many bulls and this is when market advances stall. Currently, the value of the indicator is 69.07%. Values less than 50% are associated with market bottoms. Values greater than 58% are associated with market tops. It should be noted that the market topped out in 2011 with this indicator between 70% and 71%.

Figure 3. Rydex Total Bull v. Total Bear/ weekly

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Tags: American Association Of Individual Investors, Company Insiders, Dollar Value, Dumb Money, Durable Bottom, Equity Investor, Extreme Levels, Figure 1, Guy Lerner, Inflection, Inflections, Investor Sentiment, Juncture, Market 1, Market Timers, Marketvane, Moving Averages, Put Call Ratio, S&P500, Smart Money
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Technical Take: Market Internals Have Broken Down

Wednesday, May 16th, 2012

by Guy Lerner, The Technical Take

Figure 1 shows a weekly chart of the S&P Depository Receipts (symbol: SPY).  The indicator in the lower panel is constructed from the 9 SP500 sector ETF’s (data hidden).  The indicator assesses the relative strength of each sector utilizing a 13 week look back period.  As you can see, the indicator is rolling over.

Figure 1. SPY/ Relative Strength/ weekly

Now look at figure 2 which is the same graph, but this time I have added an analogue of our “dumb money” indicator in the lower panel.  (When the value is “up”, that means there are too many bears, which is a bull signal.)  Going back to 2000, the breakdown in the indicator is associated increasing number of bears.  The gray vertical lines indicate those two times where the breakdown in market internals failed to bring about the bears.  As market internals (i.e., sector ETF’s) are breaking down, it is my expectation that investors will turn bearish.  Shortly after that, it will be time to buy.

Figure 2. SPY/ Relative Strength/ Investor Sentiment/weekly

Taking another perspective, I still contend that it is too early to “BTFD”.  Looking at this data, we still need to wait for investors to turn bearish.

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Tags: Amp, Analogue, Bears, Copyright, Depository Receipts, Dumb Money, Expectation, Figure 1, Graph, Guy Lerner, Investor Sentiment, Investors, Nbsp, Perspective, Relative Strength, S&P500, Spy, Vertical Lines
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This Time is Different ….This is Not What You Think

Thursday, May 3rd, 2012

by Guy Lerner, The Technical Take

The very erudite Dr. John Hussman is as good as a market researcher as there is, and he defines a set of market conditions that when they come together generally leads to poor equity performance.  One of Hussman’s syndromes is the “overbought, over-bullish, overvalued, and rising yields syndrome.”

My own research would agree this assessment.  The markets tend not to do well when yields are rising and when investor sentiment is overly bullish.  These constructs have formed the basis of some of my most basic and robust trading models, and this combination of excessive investor bullishness and rising yields is at the core of my “Will Robinson” signal.  Will Robinson was the young boy on the 1960′s TV show, “Lost in Space”, and when he was in danger, his robot friend would exclaim, “Danger, Will Robinson, danger!”  So when I see this constellations of market findings, it is usually danger ahead for the equity markets.

So what does this have to do with the current market environment?  From this perspective very little as I currently don’t find these conditions in the current market environment.  Over the past couple of weeks, bullish sentiment (and market “over -boughtness”) has been unwinding slowly, and as my bond trading is positive (i.e., lower yields), I am not expecting yield pressures to be a factor.  Valuations, as measured by the Shiller 10 year P/E ratio or cyclical adjusted PE ratio, remains lofty, yet truth be told, valuations are a poor market timing tool anyways.

But while Hussman is “right” about the “overbought, over-bullish, overvalued, and rising yields syndrome” and market weakness, the opposite set of conditions is probably a market positive.  The current market environment shows more bulls than bears (but necessarily extreme) and falling yield pressures.  Historically, this combination of factors has been associated with some of the more memorable price runs in recent market history.  For example from March, 1995 to February, 1996 under similar conditions, the SP500 gained approximately 30%.  There was a repeat from May, 1997 to May, 1998 when the SP500 gained 34%.  This set of conditions were also seen at the 2003 market bottom, and the late 2006 through 2007 blow off market top.  Needless to say, it does take bulls to make a bull market, and by the way, it does help to have falling interest rates.  So maybe this is why investors are currently all lathered up.

But I would contend that you need to be careful for what you wish for as something has happened to the relationship between bonds and stocks over the past 2 years.  In 2010 and 2011, falling bond yields have not been beneficial to equities.  Rather, falling bond yields, as measured by bullish signals from our bond model, have been a sign of economic weakness, and have led to crushing (i.e., poor) returns in the equity markets.  When bond yields were falling and when investors were more bullish than bearish, the SP500 had two draw downs exceeding nearly 15%.  From the 1970′s to the late 1990′s it was rare (< 5% occurrence on 70 unique instances) for such market conditions to even have a draw down greater than 6%.

I suspect investors remember those good old days from the 1990′s when the Federal Reserve had the luxury to put the pedal to the metal and keep rates low despite extreme investor enthusiasm and market overvaluations.  They don’t have that luxury now, and the only reason for the Fed to continue act in such a fashion is economic weakness.  Our bond model is currently positive suggesting lower yields.  While investors want to hark back to the “good old days”, I don’t think that is the correct interpretation.  I believe this signal suggests economic weakness as it did in 2010 and 2011.  This time is different as lower bond yields won’t see a blast off in equity prices.

Copyright © The Technical Take

Tags: Bond Trading, Bullish Sentiment, Constellations, Constructs, Current Market, Danger Will Robinson, Dr John, Guy Lerner, Investor Sentiment, John Hussman, Lost In Space, Market Environment, Market Researcher, Market Timing, Market Weakness, Pe Ratio, Robot Friend, S Tv, Syndromes, Timing Tool, Valuations
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Roller Coaster Returns (Sonders)

Wednesday, May 2nd, 2012

April 27, 2012

After an extended, and almost unprecedented period of relative calm, resulting in robust stock market gains from October 2011 through March 2012, we have seen some volatility return. Concerns over global growth have reemerged as Chinese economic data has disappointed, the European debt crisis again is gaining headlines as the merits of austerity are being questioned, and US economic data has been less impressive.

Volatility has picked up

Source: FactSet, Chicago Board of Trade. As of Apr. 24, 2012.

One potential benefit of this rise in consternation has been the long-awaited correction in stocks that many had been calling for. In fact, we have been comforted by numerous investor sentiment readings now showing elevated bearishness (remember that investor sentiment is a contrary indicator). The American Association of Individual Investors’ (AAII) bull ratio recently moved decidedly below the 50% mark for the first time in 2012. The percentage of respondents saying they are bearish has moved from just under 28% to nearly 42% between April 4 and April 11; and the percentage of bulls dropped to 28% from over 38% over the same time period. We believe this change in sentiment was needed in order for the market to reestablish a sustainable uptrend going forward.

The recent mild increase in volatility again reminds us that it’s important to maintain a long-term focus and to maintain a diversified portfolio. It’s vital that investors review their portfolio holdings on a regular basis, while also looking at how correlations among asset classes change over time. A well-diversified portfolio in one year may not be nearly so two years later, even if the positions are roughly the same—the interaction between asset classes changes over time. One final note on portfolio construction: The drumbeat of bearish bond commentary has grown over the past month as yields remain near record lows. While we again remind investors that investing in bonds for speculative or capital appreciation purposes has become more risky; it is also true that for diversification, income, and capital preservation purposes, bonds will still have a valuable place in many portfolios. Again, balance is the key.

Macro concerns again trumping micro story

Investors’ attention is again focused on the macro rather than the micro over the past couple of weeks—the height of first quarter earnings season. The reporting period has been much better than expected, although admittedly from a lower bar—83% of companies have beaten expectations so far, which is an all-time record high. But market reactions to good reports have been more muted relative to the punishments doled out to those that disappointed. It appears Chinese developments, European debt and growth concerns, and some softening in US economic data has led to increased volatility.

In the United States, the economic expansion continues, but we may be in yet another soft spot. This isn’t surprising given the likely pulling forward of some economic activity that was influenced by the unusually warm weather during the winter months. We believe this is a relatively modest and temporary phenomenon and that activity will again pick up in the coming months. Concern has grown that 2012 will be a repeat of the previous two years when the market declined beginning in April on softening economic data after decent starts to the year. We believe the story is different this time as jobs, lending and housing have improved and inflation has eased, allowing global central banks to keep policy loose; leading to our view that history won’t repeat this year.

Recently, we’ve seen regional manufacturing surveys disappoint, although remaining in territory depicting growth. The Empire Manufacturing Index fell from 20.2 to 6.6 and the Philly Fed Index dropped to 8.5 from 12.5. Encouragingly, the employment expectation component of Philly Fed jumped six points to its highest level in a year, while March retail sales increased 0.8%, above estimates, indicating that the American consumer remains engaged. Commodity costs have also leveled off recently, which should help to bolster discretionary income.

Lower commodity prices should help consumers

Source: FactSet, Standard & Poor’s. As of Apr. 24, 2012.

Despite this still-positive picture, recent job and housing data has weakened a touch. The March payroll report disappointed despite the unemployment rate dropping and recent initial jobless claims have crept a bit higher. We remain relatively unconcerned given that seasonal adjustments around the Easter holiday can be difficult and the level still remains well below the key 400,000 number. Jobs are a vital cog in the economy and we believe that increasing retail demand and a declining ability of companies to squeeze additional productivity out of existing workers should allow for continued improvement on the labor front.

Tags: Austerity, BRICs, Charles Schwab, Chicago Board Of Trade, Chief Investment Strategist, Dangerous Game, Debt Crisis, Earnings Season, Economic Data, Economic Forecasts, Election Season, Fed Meeting, Global Growth, Investor Sentiment, Liz Ann, Relative Calm, Roller Coaster, Sector Analysis, Senior Vice President, Stock Market Gains, Unprecedented Period
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