S&P 500 Index 1884
By Steve Blumenthal
May 21, 2014
The cyclical trend for both stocks and bonds remains bullish. Sentiment is once again mixed with short-term sentiment back in the Extreme Pessimism zone (a bullish reading) while my favorite sentiment indicator remains neutral.
I’ve included a chart that shows how much interest rate risk exists in the bond portion of investor portfolios. It shows the approximate gain in value for a 1% decline in rates and the approximate loss in value for each 1% increase in rates. It is the other side of QE that we should prepare for.
I continue to favor tail risk hedging stock market exposure and an allocation to tactical and alternative strategies for deeper portfolio diversification (they add valuable low correlation and risk diversification).
Included in this week’s Trade Signals:
- Investor Sentiment: Crowd Sentiment Poll is Nearing Extreme Optimism
- Daily Investor Sentiment: Bullish
- Cyclical Equity Market Trend: Big Mo Remains Bullish
- Zweig Bond Model: Continues to Signal A Bullish Trend for Bonds
- Interest Rate Gain/Loss Per Every 1% Interest Rate Move
Investment Sentiment 5-21-2014:
Sentiment Chart – NDR Crowd Sentiment Poll: Nearing Extreme Optimism
Crowd Sentiment Poll (my favorite sentiment indicator) is once again nearing Extreme Optimism (Bearish). 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).
Daily Investor Sentiment: Extreme Pessimism (Bullish)
Cyclical Equity Market Trend: Big Mo Remains Bullish
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.
Additional 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.
Zweig Bond Model: Remains a Bullish Signal for Bonds
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).
It is risk of rising rates we need to be most concerned with today.
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
Click here for Seasonal Tendencies http://www.cmgwealth.com/ri/trade-signals-seasonal-tendencies/
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. Tactical strategies can further your portfolio diversification in important ways.
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
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