S&P 500 Index 1984
By Steve Blumenthal
September 10, 2014
We can look at valuation measures to asses the degree of market risk and to get an idea as to what forward probable returns might look like (by most all measures, low). Yet overvalued markets can grow to be more and more overvalued. In this way, valuation metrics are good risk measuring tools but poor cyclical bull or bear market trend tools.
Investor sentiment can give us a feel for just how fully invested investors might be. The overall idea is to get a sense of available supply and demand. For example, when investor sentiment is extremely pessimistic, a great deal of the selling pressure has already occurred, leaving both increased liquidity and fewer sellers to get in the way when the buying returns. The reverse is true when investor sentiment is extremely optimistic. The money is already committed (buyers have already bought in and pushed prices higher. There are fewer buyers remaining to support prices when the selling starts).
My favorite sentiment indicator, the NDR Crowd Sentiment Poll, continues to show Extreme Optimism though it has not done a good job this past year. The shorter-term sentiment poll, Daily Investor Sentiment, has done a much better job. Neither is perfect but you’ll see in both charts what the market performance looks like at both extremes.
Overall, the cyclical trend remains bullish and I believe we remain in a Don’t Fight The Fed period. Perhaps zero bound interest rates leave investors asking, “where else can I possibly put my money”. This current “cash is trash” period may be why volume has been light, volatility low and the market corrections muted.
As for market valuations, Warren Buffett has been quoted as saying his favorite valuation indicator is Stock Market Capitalization as a Percentage of Nominal GDP. Without going all in geek on you, I jump to the conclusion that by this measure the market is “Very Overvalued” and more overvalued than it was in 2007 (yellow oval in the following chart).
Yet, despite this “Very Overvalued” equity market, the bigger picture points to a continuation of the bull market as suggested by both the Big Mo “buy” signal and 13/34-Week EMA Trend indicator. Don’t Fight the Fed remains an important theme and the fact that globally “cash is trash” may continue to mean that equities are the asset class of choice.
Keep in mind that the months of September and October have historically been full of downside surprises and the Fed looks to be ending QE in October. With valuations high and sentiment on the extreme bullish side, hedge your equity exposure (consider covered calls to help finance the put option protection cost) and be prepared to buy should an extreme event present itself (of course, as long as the weight of evidence continues to support a bull market view).
I’m doing some work on capital flows with the feeling that globally governments have pushed rates to zero and even negative (Germany) and that foreign investors and public pension assets may find equities (particularly U.S. corporations) to be the favored choice. Let’s continue to look to trend evidence to stay in sync with the markets cyclical trend whether it be bull or bear. More on this in a future post.
Included in this week’s Trade Signals:
- Cyclical Equity Market Trend: Cyclical Bullish Trend for Stocks Remains Bullish (as measured by NDR’s Big Momentum indicator and separately by the 13/34-Week EMA S&P 500 Index Trend Chart)
- Weekly Investor Sentiment Indicator – NDR Crowd Sentiment Poll: Extreme Optimism (Bearish for the Market)
- Daily Trading Sentiment Composite: Neutral Reading (Bullish for the Market)
- The Zweig Bond Model: The Cyclical Trend Remains Positive for Bonds (supporting bond investment exposure)
Cyclical Equity Market Trend: Cyclical Bullish Trend for Stocks Remains
Click here to see “How I Think About Big Mo”.
13/34-Week EMA Trend Chart: Cyclical Bullish Trend for Stocks Remains
Favorable trend support can also 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.
Investor Sentiment 9-10-2014:
NDR Crowd Sentiment Poll: Extreme Optimism (Bearish)
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).
The weekly NDR Crowd Sentiment Poll (one of my favorite sentiment indicators) is in the Extreme Optimism zone – bearish for stocks. Note the red arrow and the poor historical equity market performance when the majority of investors are bullish.
“The secret to my success is that I buy when everyone else is selling and I sell when everyone
else is buying. Sounds easy to do yet it will be one of the hardest thing for an investor to
master.” Sir John Templeton, the Union League, Philadelphia 1985
Note that the average value of the indicator at Extreme Optimism (1995 to present) is 68.2. The idea here is that one wants to be a buyer when everyone else is selling (Extreme Pessimism) and a seller or equity hedger when everyone is extremely optimistic.
Daily Trading Sentiment Composite: A Neutral Reading (Remains Bullish for the Market)
Next let’s take a look at trend evidence in the bond market.
The Zweig Bond Model: The Cyclical Bullish Trend Remains Positive for Bonds
Historical performance is summarized in the table on the bottom right. The yellow highlight shows the current buy signal for the strategy and historical performance on signal (the model was established in the 1980s – the data is hypothetical). The blue line shows the growth of $100 since April 1, 1967 in comparison to the black line which is the Barclays Aggregate Total Return index. The table at the bottom left compares the two.
Click here for notes on “How To Track The Zweig Bond Model” on your own.
Given the historically low yield on bonds, it is important to understand what happens to bonds when interest rates rise. However, for now, the weight of evidence continues to support being positioned in longer-term bonds, bond fund ETFs and/or bond mutual funds.
Interest Rate Gain/Loss Per Every 1% Interest Rate Move
*Think about the above chart as it relates to trading bond fund ETFs tied to the Zweig Bond Model signals, as well as the current high risk environment tied to ultra low interest rates.
Concluding Thoughts
The equity market trend remains positive, the bond market trend remains bullish, our CMG Managed High Yield Bond Program remains in a buy signal but is very near a sell signal. Our CMG Tactical Rotation Strategy remains long SPY (S&P 500 Index ETF) and VNQ (Vanguard REIT ETF) and our CMG Opportunistic All Asset Strategy remains bullish on both equities and fixed income with significant weights to equity funds and equity ETFs.
Overall, risk remains elevated, the market remains overvalued and some form of risk protection simply makes sense. I favor 30/30/40 with the 30% to equities hedged, 30% to fixed income flexibly managed due to low interest rates and 40% to tactical and alternative strategies. Within that last category, I favor a 10% allocation to precious metals.
More aggressive accounts might overweight equities (something in the order of 70% equities and 30% tactical). Be sure to have an “always on” equity hedge as such insurance is a small expense that protects your portfolio and, importantly, it may put you in the favorable position to take advantage of the opportunities the next crisis will create.
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
https://www.trademonster.com/marketing/upcomingWebinarEvents.action?src=TRADA2&PC=TRADA2&gclid=CKna3Puu6rwCFTRo7AodRiQAlw
IMPORTANT DISCLOSURE INFORMATION
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