S&P 500 Index 1913
By Steve Blumenthal
May 28, 2014
There are a number of ways one can measure the equity markets’ primary trend. My favorite cyclical bull/bear market trend chart is NDR’s Big Mo. As you’ll see in the most recent chart below, Big Mo remains constructive on the market. The last buy signal was on October 14, 2012. The S&P 500 Index was at 1224.58. 84.6% of trades have been profitable dating back to 1980.
Investor sentiment has moved back into the Extreme Optimism (Bearish) zone and I suspect it will move higher in the near-term (signaling even more optimism). When everyone is bullish, it is time to get bearish – as can be seen by the negative gain/annum when sentiment is in Extreme Optimism.
Other issues exist: low volume, record high margin, an aged cyclical bull, the negative May to October seasonal tendency, relatively high valuations coupled with peak profit margins, QE’s enviable exit and, of course, the global systemic risks tied to excessive developed market debt and Central Bank intervention.
Here are some of the notable recent crises:
October 1987 – DJIA fell 22% in one day
1990 Savings and Loan crisis
1994 Mexican Peso crisis
1997 Asian crisis (Thailand)
1998 Russia and Long-Term Capital Management crisis
2000 Dot-com crash
2007 Mortgage crisis
2008 Stock market crash
The game plan today is creating portfolios with a thoughtful allocation to equities (hedged with inexpensive tools such as put options) combined with a diverse allocation to tactical and other less correlated return streams – leaving you in an advantageous position when the next crisis hits.
Included in this week’s Trade Signals:
- Cyclical Equity Market Trend: Big Mo Remains Bullish
- Investor Sentiment: Crowd Sentiment Poll is Back to Extreme Optimism (Bearish)
- Zweig Bond Model: Continues to Signal A Bullish Trend for Bonds
- Additional Information Along with Charts on Trend, Sentiment and Interest Rate Risk
Cyclical Equity Market Trend: Big Mo Remains Bullish
See “How I Think About Big Mo” below.
Investment Sentiment 5-28-2014:
Sentiment Chart – NDR Crowd Sentiment Poll: Back to Extreme Optimism (Hedge)
Crowd Sentiment Poll (my favorite sentiment indicator) is once again in the Extreme Optimism (Bearish) zone. Note red arrow and the poor historical equity market performance when the majority of investors are bullish.
If you are a new reader, the gray area highlights the historical market performance when Investor Sentiment, as measured by Ned Davis Research, moves into the Extreme Optimism (Bearish) Zone (above the dotted black line or a reading of 66).
Zweig Bond Model: Remains a Bullish Signal for Bonds
See “How To Track The Zweig Bond Model” below.
Additional Information along with Charts on Trend, Sentiment and Interest Rate Risk
How I think about using Big Mo:
I like to think of Big Mo as a risk-timing tool. This is far different than market timing. The idea is to hedge the portion of your portfolio invested in equities against periods of major market risk. While no indicator is perfect and past performance guarantees you nothing in this business, Big Mo has done a good job identifying the major market trends. It is my favorite stock market trend indicator.
The orange box highlights historical performance. The yellow circle marks the last Big Mo trade signal.
The NDR Big Mo Multi-Cap Tape Composite Model was created to give a composite reading on the technical health of the broad equity market. The model uses trend and momentum indicators based on a broad array of our NDR Multi-Cap cap-weighted sub-industry group price indices. Trend indicators are based on the direction of a sub-industry’s moving average, while the momentum indicators are based on the rate of change of the sub-industry’s price index. By including many indicators together in the composite model, the process quantitatively analyzes the “weight of the evidence” regarding the market’s trend and momentum rather than relying on only one or a few indicators.
Favorable trend support can be seen in the following 13/34-week trend chart:
13/34-week EMA – The cyclical bull market’s uptrend remains in place. Note the blue 13-week EMA line remains above the red 34-week EMA line. Also note how well this simple, tactical trend indicator has historically captured the cyclical bull and bear market trends. Signals occur when the lines cross.
How To Track The Zweig Bond Model
The idea is to stay with the trend. Despite Wall Street analysts’ estimates for a yield north of 3% by the end of 2014 (which still may prove correct) rates have fallen – not risen. This model has been properly long bonds since late last year.
This is something you may want to consider as it relates to your bond exposure. The process is highlighted in the top left of the chart. There are five steps.
Here is how the tactical trend following model works:
- Score a +1 when the Dow Jones 20 Bond Price Index (index symbol $DJCBP) rises from a bottom price low by 0.6%. Score a -1 when the index falls from a peak price by 0.6%.
- Score a +1 when the Dow Jones 20 Bond Price Index rises from a bottom price by 1.8%. Score a -1 when the index falls from a peak price by 1.8%.
- Score a +1 when the Dow Jones 20 Bond Price Index crosses above its 50-day moving average by 1%. Score a -1 when the index crosses below its 50-day by 1%.
- Score a +1 when the Fed Funds Target Rate drops by at least ½ point. Score a -1 when the rate rises by at least ½ point. Score +1 if a buy and -1 if a sell.
- Score a +1 when the yield difference of the Moody’s AAA Corporate Bond Yield minus the yield on 90-day Commercial Paper Yield crosses above 0.6. Score a -1 when the yield difference falls below -0.2. Score it 0 for a neutral score between -0.2 and 0.6.
- Score up the sum total of steps 1 through 5 once a week (the chart below reflects Friday’s close calculations). If the total sum is +1 or higher, invest in a total bond market ETF like BND (Vanguard Total Bond Market ETF) or AGG (iShares Barclays Aggregate Bond Index ETF). If the aggregate score is -1 or lower, buy BIL (SPDR Lehman 1-3 Month T Bill ETF).
As reflected in the following chart, the annual gain per annum was 9.71% vs. a buy-and-hold gain of 7.12%.
The process was developed in the mid-1980s and remains the same since. The data goes back to 1967 with the Barclays Aggregate Bond Index to 1976 and the Ibbotson Long-Term U.S. Bond Index from 1967 to 1976. I intend to post this chart each Wednesday in Trade Signals. Over that stretch of time, the model has done a good job at enhancing return and reducing risk in rising rate environments (highlighted orange rectangle).
The bottom section of the chart shows the combined score of the model’s five measurements. A buy is generated on scores > 0 and a sell on scores < 0. The model remains in a buy signal. ETFs such as BND can be used to express the view.
I received a larger than normal number of emails asking if we can run this strategy in a SMA (managed account). The answer is that while I believe it is a solid investment process, we run several strategies on our managed platform that I believe are superior though, in my view, the process is sound.
As a quick aside: If you choose to trade following the Zweig model or any other process for that matter, there are several important questions to ask yourself: Do you have the time to follow the model every day? Do you have the infrastructure in place to trade across multiple accounts? Can you execute ETF trades with little market impact and trade for very low commission? Do you have the conviction and belief necessary to follow the process through both losing trades and winning trades? Can you stick to the process over time?
I have traded our high yield trend following strategy for more than 20 years. I can honestly say there were a few times in the early years I thought I was smarter than the process. I was usually wrong – the process right. Emotion and ego are strong forces. You have to eliminate them and stick to the process. No small thing. I frequently say that half the battle is having a sound process and the other half is having the discipline to stick to the process.
So if you don’t have the time and/or infrastructure then find some flexible bond funds and/or managed bond strategies. Many exist. Several are outstanding.
Interest Rate Gain/Loss Per Every 1% Interest Rate Move
Concluding Thoughts
No major changes:
The cyclical trend remains positive as measured by Big Mo, investor sentiment is mixed and the Fed is supportive for now. The seasonally challenged May to October period has arrived. I believe that putting hedges in place remains the prudent thing to do. Risk is so significantly elevated due to Fed manipulation and market valuations are relatively high while profit margins are stretched. The system is more leveraged than it was in 2008 and this cyclical bull is aged. Therefore, if viewed in one picture, I see risk today like this (Red is most risk, Green is least risk):
Please let me know if you have any questions. (see important disclosures below)
With kind regards,
Steve
Stephen B. Blumenthal
Founder & CEO
CMG Capital Management Group, Inc.
Philadelphia – King of Prussia, PA
steve@cmgwealth.com
610-989-9090 Phone
Provided are several links to learn more about the use of options:
For hedging, I favor a collared option approach (writing out of the money covered calls and buying out of the money put options) as a relatively inexpensive way to risk protect your long-term focused equity portfolio exposure. Also, consider buying deep out of the money put options for risk protection.
Please note the comments at the bottom of this Trade Signals discussing a collared option strategy to hedge equity exposure using investor sentiment extremes is a guide to entry and exit. Go to www.CBOE.com to learn more. Hire an experienced advisor to help you. Never write naked option positions. We do not offer options strategies at CMG.
Several other links:
http://www.theoptionsguide.com/the-collar-strategy.aspx
IMPORTANT DISCLOSURE INFORMATION
Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk. Therefore, it should not be assumed that future performance of any specific investment or investment strategy (including the investments and/or investment strategies recommended and/or undertaken by CMG Capital Management Group, Inc (or any of its related entities-together “CMG”) will be profitable, equal any historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. No portion of the content should be construed as an offer or solicitation for the purchase or sale of any security. References to specific securities, investment programs or funds are for illustrative purposes only and are not intended to be, and should not be interpreted as recommendations to purchase or sell such securities.
Certain portions of the content may contain a discussion of, and/or provide access to, opinions and/or recommendations of CMG (and those of other investment and non-investment professionals) as of a specific prior date. Due to various factors, including changing market conditions, such discussion may no longer be reflective of current recommendations or opinions. Derivatives and options strategies are not suitable for every investor, may involve a high degree of risk, and may be appropriate investments only for sophisticated investors who are capable of understanding and assuming the risks involved. Moreover, you should not assume that any discussion or information contained herein serves as the receipt of, or as a substitute for, personalized investment advice from CMG or the professional advisors of your choosing. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisors of his/her choosing. CMG is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice.
This presentation does not discuss, directly or indirectly, the amount of the profits or losses, realized or unrealized, by any CMG client from any specific funds or securities. Please note: In the event that CMG references performance results for an actual CMG portfolio, the results are reported net of advisory fees and inclusive of dividends. The performance referenced is that as determined and/or provided directly by the referenced funds and/or publishers, have not been independently verified, and do not reflect the performance of any specific CMG client. CMG clients may have experienced materially different performance based upon various factors during the corresponding time periods.
CMG Global Equity FundTM and CMG Tactical Futures Strategy FundTM: Mutual Funds involve risk including possible loss of principal. An investor should consider the Fund’s investment objective, risks, charges, and expenses carefully before investing. This and other information about the CMG Global Equity FundTM and CMG Tactical Futures Strategy FundTM is contained in each Fund’s prospectus, which can be obtained by calling 1-866-CMG-9456. Please read the prospectus carefully before investing. The CMG Global Equity FundTM and CMG Tactical Futures Strategy FundTM are distributed by Northern Lights Distributors, LLC, Member FINRA. NOT FDIC INSURED. MAY LOSE VALUE. NO BANK GUARANTEE.
Hypothetical Presentations: To the extent that any portion of the content reflects hypothetical results that were achieved by means of the retroactive application of a back-tested model, such results have inherent limitations, including: (1) the model results do not reflect the results of actual trading using client assets, but were achieved by means of the retroactive application of the referenced models, certain aspects of which may have been designed with the benefit of hindsight; (2) back-tested performance may not reflect the impact that any material market or economic factors might have had on the adviser’s use of the model if the model had been used during the period to actually mange client assets; and, (3) CMG’s clients may have experienced investment results during the corresponding time periods that were materially different from those portrayed in the model. Please Also Note: Past performance may not be indicative of future results. Therefore, no current or prospective client should assume that future performance will be profitable, or equal to any corresponding historical index. (i.e. S&P 500 Total Return or Dow Jones Wilshire U.S. 5000 Total Market Index) is also disclosed. For example, the S&P 500 Composite Total Return Index (the “S&P”) is a market capitalization-weighted index of 500 widely held stocks often used as a proxy for the stock market. Standard & Poor’s chooses the member companies for the S&P based on market size, liquidity, and industry group representation. Included are the common stocks of industrial, financial, utility, and transportation companies. The historical performance results of the S&P (and those of or all indices) and the model results do not reflect the deduction of transaction and custodial charges, nor the deduction of an investment management fee, the incurrence of which would have the effect of decreasing indicated historical performance results. For example, the deduction combined annual advisory and transaction fees of 1.00% over a 10 year period would decrease a 10% gross return to an 8.9% net return. The S&P is not an index into which an investor can directly invest. The historical S&P performance results (and those of all other indices) are provided exclusively for comparison purposes only, so as to provide general comparative information to assist an individual in determining whether the performance of a specific portfolio or model meets, or continues to meet, his/her investment objective(s). A corresponding description of the other comparative indices, are available from CMG upon request. It should not be assumed that any CMG holdings will correspond directly to any such comparative index. The model and indices performance results do not reflect the impact of taxes. CMG portfolios may be more or less volatile than the reflective indices and/or models.
In the event that there has been a change in an individual’s investment objective or financial situation, he/she is encouraged to consult with his/her investment professionals.
Written Disclosure Statement. CMG is an SEC registered investment adviser principally located in King of Prussia, PA. Stephen B. Blumenthal is CMG’s founder and CEO. Please note: The above views are those of CMG and its CEO, Stephen Blumenthal, and do not reflect those of any sub-advisor that CMG may engage to manage any CMG strategy. A copy of CMG’s current written disclosure statement discussing advisory services and fees is available upon request or via CMG’s internet web site at (http://www.cmgwealth.com/disclosures/advs).